Negative interest cannot fix the economy

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The central bankers of this world seem to think it is their mission to make the economies in their respective countries or regions (and in combination the global economy) run smoothly, and to this end they have been experimenting with some increasingly radical policy options. Here are the basic policies we have in mind, all of which tilt the monetary scales in favor of borrowers versus savers.

#Freeze short-term interest rates versus letting them be determined by the market. Thus, the Federal Reserve held its short-term funds rate at a near zero level from 2009 until December 2015. Fed funds rate, trading,


It may have been appropriate to minimize the federal funds rate in the aftermath of the 2008 financial crisis/recession, but we believe the Fed waited too long to start moving back to more normal rates. Fed mulls shift in monetary policy, 9/7/15.

When the Fed raised the federal funds rate by 25 basis points in December 2015, it was understood that there would be several additional increases over the next year or two. Given current concerns about the global economic outlook, however, these increases may well be deferred for a while.

#Purchase longer-term securities to artificially depress longer-term interest rates (aka quantitative easing), thereby encouraging investors to acquire riskier investments offering higher returns. As the result of several rounds of QE, the last of which began in 2012 (Federal Reserve launches another monetary policy experiment,
9/17/12), the Fed is currently holding some $4 trillion in debt securities. Federal Reserve Bank of St. Louis, 2/10/16.
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While no further QE is going on, there is apparently no plan to reduce this portfolio over time, e.g., by not acquiring replacements for maturing debt securities.

#Going beyond near zero interest rates, the central banks in several European countries and Japan are now charging fees (aka negative interest) on some (or in the case of Sweden all) bank reserve deposits. And Federal Reserve Chair Janet Yellen has indicated that the US central bank might consider similar policies in the event of an economic downturn. Yellen on negative rates: “We wouldn’t take those off the table,” Jeff Cox,,

In light of the experience of European countries and others that have gone to negative rates, we're taking a look at them again, because we would want to be prepared in the event that we would need (to increase) accommodation. We haven't finished that evaluation. We need to consider the institutional context and whether they would work well here. It's not automatic.

Discussion follows of several reasons for concluding that the tinkering of the central bankers is likely to do more harm than good.

FIRST, the foregoing policies have been justified by claims that the economy will perform best with a moderate rate of inflation (2% per year is considered ideal) and that even a whiff of deflation (general price levels falling) should be avoided like the plague.

This overlooks the fact that the global economy has functioned quite well during deflationary periods, e.g., the 1870s and 1880s. Prevalence of the gold standard reduced risk of large exchange rate fluctuations – governments were improving their fiscal positions dues to robust economic growth and rising tax revenues – emerging market spreads were narrowing. The ascent of money: A financial history of the world, Niall Ferguson, Penguin Press,

Politics aside, moreover, we have yet to encounter a convincing argument as to why moderate inflation (slow enough so people won’t be constantly reminded of their loss of purchasing power) is necessarily more desirable than a corresponding amount of deflation. Fed mulls shift in monetary policy,

Why is 2% inflation necessarily better than, say, 2% deflation? The real point is not the maximization of economic output, but rather whether the interests of borrowers or savers will be favored. And in the spirit of fairness, we would suggest that the most appropriate goal would be general price stability, i.e., neither class should be favored over the other. Some might dismiss a 2% rate of inflation as trivial, but this rate compounds to 22% over a decade; that may not seem like a minor matter for retirees and others living on a fixed income.

Consider the bootstrap argument of one Fed official (John Williams, president of the Federal Reserve Bank of San Francisco) on this subject. Federal Reserve’s foolishness continues to fester, Steve Forbes,

When asked how a 2% rise in the cost of living - which would add an additional $1,000 in expenses annually for the average American family–would boost the economy, Williams, with the insouciance of the obliviously ignorant, responded that the inflation would lead to a 3.5% rise in real wages. In other words, $1,000 in extra expenses would trigger a rise in a family’s income of almost $3,000. If only!

SECOND, these policies involve potentially serious side effects. Thus, abnormally low interest rates can undermine the incentive to save money, which is required to fund the capital investments that are needed to support longer-term economic growth. And artificial encouragement of riskier investments tends to produce asset bubbles, which will pop eventually with much resultant disruption.

The resort to negative interest policies is a comparatively recent development, but issues are already showing up. Here are some of them:

•It was reasoned that banks would decide to loan their excess reserves instead of holding reserve balances subject to negative interest charges, thereby promoting productive investment. But the negative interest won’t increase the supply of attractive investment opportunities, so it’s hard to see why the hoped-for result would necessarily follow.

As the charges represent a cost of doing business for banks that cannot be readily passed on to depositors, banks may have to shrink their operations or raise their lending rates. The net effect might be to discourage (not encourage) productive lending. Negative central bank interest rates now herald new danger for the world, Mehreen Khan, UK Telegraph,

So far, "banks seem unable or unwilling to pass negative deposit rates to their retail customers, leaving them with few options to offset costs", note analysts at JP Morgan. They also highlight that, should banks start imposing higher lending costs on their customers, this would have the reverse effect of easy monetary policy, crimping credit creation and tightening financial conditions.

Furthermore, excess reserves may wind up being sent to other countries – as shown by the offshore investment boom in Japan – instead of fueling domestic investment. The biggest winner of Japan’s negative rate experiment may be overseas, Mike Bird,,

•One reason that some central banks began experimenting with negative interest rates was the hope of shielding the host country’s currency from continuing appreciation. Even this goal, however, will not necessarily be achieved. Negative central bank interest rates now herald new danger for the world, Mehreen Khan, UK Telegraph,

Like its counterparts in northern Europe, Japan's sub-zero rates were intended to drive down the value of its currency, the yen. It didn't work. The yen has now risen by 10pc against the US dollar since the Bank of Japan's negative interest rate decision on January 30.

•Instead of dropping the idea of negative interest rates, the bureaucratic elite may be inclined to double down on it. If so, further problems could result.

One way to lessen the resistance of bank customers to negative interest would be to make it more difficult for them to hold cash outside the banking system. How? For starters, ban high denomination money, e.g., $100 bills. And over time, require more and more payments to be made electronically so there would ultimately be a digital record of all monetary transactions.

In addition to facilitating fees on bank deposits, a cashless economy would streamline payment processes (no more making change), eliminate the handling of unsanitary bills and coins, put a stop to counterfeiting (but not cybercrime, of course), and complicate the lives of tax cheats, criminals and international terrorists. It’s time to kill the $100 bill, Lawrence Summers, Washington Post,

Transitioning to a cashless society would augment the power of governments and financial intermediaries, however, while curbing the freedom of individuals to spend their money as they see fit without a lot of transaction costs. It’s far from clear that the net results would be positive. The political war on cash, Wall Street Journal,

By all means people should be able to go cashless if they like. But it’s hard to avoid the conclusion that the politicians want to bar cash as one more infringement on economic liberty. They may go after the big bills now, but does anyone think they’d stop there? Why wouldn’t they eventually ban all cash transactions much as they banned gold and silver as mediums of exchange? Beware politicians trying to limit the ways you can conduct private economic business. It never turns out well.

Carrying the negative interest idea to its logical end, imagine a system in which the Fed not only charged money on deposits but also paid banks to take out loans. What a mess that would make; sounds like quantitative easing on steroids! Why negative interest rates spell doom for capitalism, Robert Romano,,

THIRD, tinkering with exotic monetary policies tends to divert attention from other policy changes that governments need to make – but politicians view as a last resort - such as cutting wasteful government spending, streamlining the tax system, and restructuring entitlements.

Central bankers should stop pretending that they can make up for the policy blunders of legislators and administrators, when most of them know it isn’t so. Time for a central bankers strike, Holman Jenkins, Wall Street Journal,

The central banks have a club, known as the Bank for International Settlements, in Basel, Switzerland, which last year in a message to members stated the obvious: “Monetary policy has been overburdened for far too long. It must be part of the answer but cannot be the whole answer. The unthinkable”—large-scale asset purchases, negative interest rates—“should not be allowed to become routine.” ***And now maybe it’s time for the BIS to take its critique to its logical conclusion—calling on the world’s central bankers to go on strike until politicians and fiscal policy makers start doing their bit to get growth restarted and put the industrial economies back on a path to solvency.

As for the results of all the central bank activity since 2008, the economic recovery has been anemic and another global recession may well be in the making. 21 new numbers that show the global economy is absolutely imploding, Michael Snyder,,

Chinese exports fell by 11.2 percent year over year in January, while Chinese imports fell even more *** Indian and Japanese exports also down sharply *** Japanese GDP growth negative for the sixth year in a row *** US factory orders have fallen for 14 months in a row **Baltic Dry Index (bulk shipping rates) fell below 300 for the first time ever *** Daimler just laid off 1,250 US workers due to low truck demand – oil prices have fallen to around $30 per barrel – 67 US oil and gas companies filed for bankruptcy during 2015 – wave of retail store closings (Wal-Mart, K-Mart, J.C. Penney, Macy’s, Sears, etc.) – global stock prices in bear (20% loss) territory.

Meanwhile, the central bankers are basically out of ammunition. Ibid.

Since March 2008, central banks have cut interest rates 637 times and they have purchased a staggering 12.3 trillion dollars worth of assets. There is not much more that they can do, and now the next great crisis is upon us.

Could a turn away from the ever bigger and more intrusive government model really help matters? You bet, and we’re not the only ones who think so. In search of fixes for a stagnant economy, Victor David Hanson, Washington Times,

Perhaps it is time to try something radically different — or rather, traditional — such as balancing the budget through additional cutting more than additional taxing, on the theory that individuals are more accountable and efficient than government bureaucracies.

The tax code is so complicated and Byzantine that most Americans cannot even fill out their own forms and either waste hours of their time, cheat end up not filing at all, or look for deductions and write-offs that often retard economic growth. Tax reform and a return to moderate interest rates certainly could not make things any worse.

Reducing regulations would encourage businesses to invest and expand. Government growth and red tape not only stifle creativity but also encourage costly abuse — at least if recent serial scandals in government agencies are any indication.

So isn’t it about time that our political leaders got on with the job?


Negative interest is a phony tool. If there were lots of attractive investment opportunities, banks wouldn’t need to be prodded to make loans. And the absence of such opportunities is a function of anti-business policies, e.g., high taxes, heavy-handed regulations, pro-union bias, etc. – SAFE director

It’s been suggested that even worse monetary policy gimmicks may be on the drawing board. Get ready to be showered by helicopter money, Matthew Lynn, UK Telegraph, 2/22/16.

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