Negative Interest Rate

9 Key excerpts on "Negative Interest Rate"

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  eBook - ePub

  Negative Interest Rates and Financial Stability

  Lessons in Systemic Risk

  • Karol Rogowicz, Małgorzata Iwanicz-Drozdowska(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  2 Negative Interest Rate Policy – A Theoretical Outline

  DOI: 10.4324/9781003312116-2

  2.1 The Concept of Interest Rate in Economics and Finance

  In market economy, interest rate is among the key parameters underlying economic decision-making process. The economic literature provides several interest rate definitions, including the structure of its functions and its typology. Typically, interest rate in the economy is construed as a particular type of price/money cost (i.e., intertemporal price), much as definition approaches vary depending on the school of economic thought. Notwithstanding the tentative interest rate definition, the literature points out to its four major functions (e.g., Masiukiewicz, 1994 ): (i) allocation, which involves affecting aggregate investment and production structure in the economy; (ii) regulation, which comes down to maintaining balance on the capital and money markets whereby the interest rate is a tool for balancing supply and demand of loan capital; (iii) calculation, which enables examining the profitability of business entities’ investment decisions; and (iv) yield, which involves calculating income on capital investment. Analysis of the above functions is crucial as introducing a Negative Interest Rate policy may induce a disruption of this fundamental mechanism.

  2.1.1 Interest Rate Theories

  According to the classical school of economics, the interest rate – although the classical economics alone did not relatively elaborate much on its very concept – may be viewed as a part of profit (e.g., according to A. Smith) or as premium paid for holding goods now versus the possibility to use them in the future (e.g., according to I. Fisher, 1930 ). It should also be emphasized that the classical theory assumes neutrality of money in the long term and it ignores the effect it has on setting the interest rate. It means that the existence of money is not a prerequisite for the interest rate to exist. From this perspective, classicists and neo-classicists (including I. Fisher) viewed the interest rate as a non-monetary category. At the same time, in their considerations, they denied it could be used as an active monetary policy instrument (Bilski, 2012 ). It is because, following Fisher’s theory, interest rate was market-developed by equating savings (supply of liquid capital, positively dependent on interest rate level) with investments (demand for liquid capital, reversely dependent on interest rate level). It is only K. Wicksell’s elaboration on this approach that showed the interest rate is determined by both real and monetary factors (Brózda-Wilamek, 2018 ). It was the first time in the history of economic thought that the role of monetary policy could be deemed as giving rise to interest rate fluctuations around the rate’s natural level. Moreover, K. Wicksell expanded the classical interest rate theory to include two additional interest rate types – a monetary rate (as a money cost charged by commercial banks on loans originated, set by supply and demand on the money market; Wicksell, 1934

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  Monetary Policy after the Great Recession

  The Role of Interest Rates

  • Arkadiusz Sieroń(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Last but not least, the NIRP also has adverse distributional effects. First, as noted above, the Negative Interest Rates harm smaller banks more than larger banks. This distorts the structure of the banking sector relative to what would exist without negative policy interest rates. Second, given that central bank reserves are not held equally across the members of the euro area, Negative Interest Rates on excess reserves affect banks from countries with large surplus positions within Target 2, such as Germany, more than banks from countries with large deficit positions within Target 2, such as Italy (Angrick and Nemoto 2017). Third, those who allocate their savings into assets will benefit from higher asset prices at the expense of those who save in bank accounts with very low, or even negative, interest rates. Fourth, people’s abilities to avoid Negative Interest Rates differ. So when banks decide to pass the costs on to account holders, wealthier individuals can avoid Negative Interest Rates more easily (by, for instance, shifting funds into gold and foreign currencies or by paying bills and taxes well in advance).

  Negative market rates

  We have so far focused on negative policy rates. But the NIRP, together with other unconventional monetary policies and other factors, has created an unprecedented situation in which nominal interest rates are negative in several European countries across a range of maturities in the benchmark yield curve, from overnight to five- or even ten-year maturities (see, for example, Figure 6.4 , which displays yields on ten-year German bonds that turned negative in 2016 and then again in 2019). The pool of negative-yielding government bonds around the world is already above $15 trillion, and about one-quarter of the world’s GDP is produced in countries with Negative Interest Rates (as of September 17, 2019) (Mourmouras 2016). Does it make any sense? Do the negative bond yields deny the laws of economics?

  Figure 6.4 Yields on ten-year German bonds from 2009 to 2019.

  Source: Stooq (2019), stooq.com , retrieved September 17, 2019.

  Not necessarily. Generally, each case of negative market rates has its own special story and should be analyzed separately. However, we can provide a few reasonable explanations for why market participants do sometimes accept negative nominal interest rates. Let us separate negative deposit rates and negative lending rates, or bond yields, and start with the former. In some countries, commercial banks simply have to maintain excessive reserves in a negative-interest-bearing account. Keeping money in bank deposits is not obligatory, but banks offer productive services related to storing money, making transfers, and so on, so negative deposit rates are fully justified. The fact that it is possible to collect fees for keeping deposits is not surprising to Austrian economists, who propose separating deposit banking and loan banking.

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  The Curse of Cash

  How Large-Denomination Bills Aid Crime and Tax Evasion and Constrain Monetary Policy

  • Kenneth S. Rogoff(Author)
  • 2017(Publication Date)
  • Princeton University Press

    (Publisher)

  The most important concern probably relates to whether negative rates might create greater temptations to engage in severe financial repression. In classic financial repression, the government sets the interest rate at a positive level, then inflates and forces captive savers to accept a significantly negative real rate of interest. With the option of negative nominal rates, the government could collect large financial repression revenues without having any inflation. And yes, this temptation could be a problem for revenue-starved governments, and could in principle lead to significant distortions. True, modern advanced economies have by and large learned to strike a balance between necessary financial regulation and distortionary financial repression, and it seems unlikely that negative rates would decisively tilt that balance. Nevertheless, it is an issue to be monitored. A good defense would simply be to insist that the central bank aim to use negative interest effectively and in a way that lifts the economy back to positive nominal rates reasonably quickly.

  All in all, modern central banks have learned to contain inflation expectations effectively through a variety of innovations relating to independence, transparency, targeting, and communication. Ultimately, in any modern monetary regime, the public has to trust the central bank’s intentions. If the central bank announces that it is aiming for 2% inflation, the public must trust that it will operate competently and responsibly to try to achieve that goal. From this perspective, the possibility of paying interest on currency (positive or negative) should be viewed as an improvement in the toolkit of the central bank without fundamentally altering the political economy that governs its actions.

  One cannot deny that some people will think that Negative Interest Rates are immoral, and explaining that they are victims of money illusion will do little to dissuade them. Then again, some people also feel very strongly about inflation, and Negative Interest Rates can in principle allow economies to operate at a much lower average level of inflation by taking the zero bound off the table. As for default on government debt, modern governments already have extensive tools for achieving partial default through financial repression. Negative rates do expand the government’s options, and it will be important to monitor abuse, but this seems like a relatively small price for having the capacity to break the zero bound in deep recessions and to restore the full efficacy of monetary policy in normal recessions. Nevertheless, the question of whether negative rates might create instability in monetary policy is likely to concern many people, so we pursue it in greater depth in the next section.

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  Negative Euro Area Interest Rates and Spillovers on Western Balkan Central Bank Policies and Instruments

  • International Monetary Fund(Author)
  • 2017(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  In fact, I headed the working group preparing the concept of Negative Interest Rates, and one of the first arguments I had was whether there was such a thing as “Negative Interest Rate” and whether we could thus use that term. I think some people remained unconvinced until the ECB finally introduced Negative Interest Rates and used that term. But beyond terminology, there was the more serious assertion that Negative Interest Rates were not merely a continuation of values on a scale that goes below zero. Rather, it was argued that lowering interest rates below zero was like cooling water below zero degrees Celsius: the physical properties would change, water would freeze, and you would suddenly be in a very different physical environment. But as Ulrich already noted: we learned that this is not the case. Negative Interest Rates are a continuation of values on a scale that goes below zero, at least within the range of Negative Interest Rates that we have experienced so far. Nothing unexpected happened; markets and the transmission mechanism continue to work. The first central bank to actually introduce binding Negative Interest Rates was the Danish National Bank. They did it in 2012, and it provided a welcome case study for us. We were in close contact with the Danish National Bank during that time, and their experience confirmed that Negative Interest Rates could be used to counter appreciation pressure on the exchange rate. In Figure 3, you can see the policy rates of different central banks. As you can see, the Swiss National Bank lowered its policy rate quickly in the autumn of 2008, like the Fed and the ECB, and we reached zero in 2011. Given that in our case the policy rate is the three-month Swiss franc Libor, and not an overnight rate, the Swiss monetary policy stance is even somewhat more expansionary at a given policy rate relative to the Fed and the ECB

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  The Case Against 2 Per Cent Inflation

  From Negative Interest Rates to a 21st Century Gold Standard

  • Brendan Brown(Author)
  • 2018(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  One key lesson of this history, which applies as much to Europe and Japan as the US, is that monetary experiments launched on the basis of being short-lived are hardly likely to be so. The monetary bureaucrats in charge and their political masters will find reason to extend and extend and subtly change the purpose from the original failed purpose to a modified subsequent purpose for which they claim success, of course prematurely. For who can confidently pronounce success before knowing the outcomes for at least the whole business cycle and in particular with respect to the extent of mal-investment and other costs of the monetary inflation. And this cautionary lesson applies as much to Negative Interest Rates as to QE.

  Negative Interest Rates in Europe and Japan 2014–18

  Indeed, one can look at the history of Negative Interest Rates in the present episode of monetary inflation. The ECB introduced Negative Interest Rates in June 2014, with the move apparently being accepted by the Bundesbank as preferable to quantitative easing. In fact, the latter came barely 18 months later, so the euro-zone ended up experimenting with both QE and negative rates; and in 2018 both were still in force, despite the German economy in boom with ample evidence of inflation in asset markets and even the weaker economies growing strongly. And the ECB was promising that both policies would continue at least for a further year (to late 2018).

  In Japan the original introduction of negative rates in February 2016 met a storm of unpopularity (amidst a rush for buying safe-boxes) and also sent bank shares into a sharp downturn. All of this most likely convinced the Bank of Japan not to proceed with further rate cuts below zero. Sub-zero rates, however, were still in place two years later despite a booming economy.

  Finally the Swiss National Bank moved to negative rates in December 2014, implicitly as a policy tool for weakening the franc; when the ceiling was abandoned for this currency in January 2015, it took negative rates even further into negative territory (centre of a −1.25% to −0.25% band at −0.75%). No surprise that three years later they had not budged despite substantial weakening of the currency, speed-up of the economy, and inflation at near 1%. Some pressure was coming to do so from the US whose Treasury had put the franc on a list of currencies to monitor for exchange rate manipulation but, so far, no action. The manipulation charge was buttressed by the way in which the Swiss negative rate was imposed (on a very small margin of free reserves, meaning that the banks in Switzerland maintained domestic customer deposit rates at zero; in effect the negative rates resembled exchange restrictions on capital inflows).

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  The Business of Banking

  Models, Risk and Regulation

  • Giusy Chesini, Elisa Giaretta, Andrea Paltrinieri, Giusy Chesini, Elisa Giaretta, Andrea Paltrinieri(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  In fact, a high percentage of debt in many countries has Negative Interest Rates. According to a recent analysis by the International Monetary Fund (2016), the expansionary monetary policies adopted by some central banks have eased the access to finance (by reducing the cost of funding and increasing the availability of credit), thus stimulating aggregate demand. However, a prolonged period of reduced interest rates can impair bank intermediation margins (and therefore profitability), given the existence of a floor in deposit interest rates, since it is dif ficult for banks to pass on the drop in interest rates to the deposits interest rates, at least in the case of households. 2 For this reason, the net interest margin is seen to be most affected in those banks with a greater proportion of financing via deposits. Likewise, the greater the proportion of variable interest rate loans in a bank, the greater the deterioration of its 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 European Central Bank (ECB) Bank of Japan (BoJ) Bank of England (BoE) Federal Reserve (Fed) Fig. 2.1 Intervention interest rates by the main Central Banks. Source: Bank of Spain. 6 P. Cruz-García et al. profitability, as a result of the fall in financial revenues due to the reduction of the money market interest rates. The European Central Bank (2016), on the other hand, highlights in its Annual Report that the expansionary measures adopted have a positive impact. The positive impact is driven by the fact that the drop in interest rates has led to an improvement in the quality of bank assets (since less risky projects are financed), an increase in lending activity and a drop in non-performing loans as a result of economic recovery.

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  The Reform of Macroeconomic Policy

  From Stagflation to Low or Zero Inflation

  • J. Perkins(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  the other macroeconomic objectives. In particular, low, zero or nega- tive inflation greatly reduces the scope for using monetary policy to stimulate activity. For nominal interest rates cannot in practice be neg- ative; so that when inflation is low or zero (and especially if it is neg- ative) real interest rates may be high even when nominal interest rates are low but positive. If the available indexes of inflation exaggerate the actual rate of inflation, the real burden of repaying debts, and the interest on them, may be increasing even when inflation as usually measured is moderately positive. Attempts by central banks to ease monetary policy by buying bonds may in such circumstances be unsuccessful in stimulating activity. People may simply hold the additional money, and interest rates not be reduced, so that activity is not stimulated. This is known as an ‘infinitely elastic demand curve for money’. In the General Theory Keynes referred to an old city saying, ‘John Bull can stand many things, but he cannot stand 2 per cent’. This was clearly intended to imply that (presumably long-term) interest rates of 2 per cent or less would lead to a lapse of confidence in the bonds bearing such a low rate. (In a period when the general level of prices was thought to be on the average as likely to fall as to rise, one must assume that this was also a minimum real rate of interest of 2 per cent.) One may call to mind the disastrous attempt of Hugh Dalton, as Chancellor of the Exchequer in the late 1940s, to reduce the long-term bond rate to about 2 per cent. The result was a failure to sell govern- ment bonds at such a low rate. This implies that, in practice, a mone- tary authority will not be wise to attempt to reduce nominal interest rates to very low levels. The constraint on its actions is therefore much tougher than the fact that nominal interest rates cannot be negative.

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  Zero Lower Bound and Monetary Policy in the Euro Area

  Optimal Monetary Policy in a Low Inflation Environment

  • Lars Protze(Author)
  • 2008(Publication Date)
  • Diplomica Verlag

    (Publisher)

  This leads to an output gap that can not be overcome with adjusting the nominal interest rate. ( ) n t t t t t t t r E i x E x ˆ ˆ 1 1 − − − = + + π σ 76 The constraint arises because no rational individual would lend money at a Negative Interest Rate when he can hold cash at zero interest rates. This is where the carry tax on money comes into action to lower the return of cash below zero. When the costless alternative of holding money is not available then interest rates can fall below zero. The maximum Negative Interest Rate is equal to the tax rate on money holdings i.e. the cost of holding cash balances. This was first proposed by Silvio Gesell. 71 The main problem is that cash balances are being held anonymously so that it is not trivial how a tax on cash should be enforced. 72 However, a tax on cash balances is a possibility to overcome the zero bound on interest rates. One possibility to tax cash balances is that bank notes have an expiration date till that they have to be presented to the treasury to be prolonged. At that date taxes could be collected. 73 This is a rather complicated procedure and demands new banknotes and a lot of bureaucracy to collect the taxes so that the benefits should be small. Another possibility is to tax the cash reserves of clearing banks at the central bank. 74 This lowers the cost of taxation dramatically and is easier to observe. This lowers the bound to a value below zero and adds more space to counteract negative developments. If for example an interest rate of zero coincides with deflation then there is a positive real return on holding cash. This could be taxed away. When the Negative Interest Rate and the tax on cash are equal households are indifferent to holding cash or money. So that shoe-leather costs cease to exist. 71 Buiter, Willem H. and Nikolaos Panigirtzoglou 1999 page 13. 72 Yates, Tony 2002 page 33. 73 Buiter, Willem H. and Nikolaos Panigirtzoglou 1999 page 18. 74 Goodfriend, Marvin 2000.

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  The Evolution of Creditary Structures and Controls

  • G. Gardiner(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Without new issues of capital to supplement their capital bases there was no hope of the banks increasing the nominal intermediated credit supply. Figures quoted by Keynes in The Treatise on Money indicate that the deposits of the London clearing banks fell slightly, from £2,023,000,000 in 1921 to £1,843,000,000 in 1925, and then rose to £1,940,000,000 in 1929. In real terms (adjusted for inflation) deposits rose sharply in value. The real meaning of the deflation-adjusted increase is difficult to The Currency Principle 127 interpret, but at least it saved the necessity for a capital injection into the banks, for deflation, as we have already noted, makes bank capital stretch further in real terms. Keynes also noted that during the same period bank deposits in the United States grew in nominal value and that the volume of industrial production increased, whereas in the United Kingdom production was slightly less in 1927 than in 1907, a depressing indication of Britain’s industrial decline. Deflation is self-perpetuating Positive nominal interest rates, that is rates above zero, can be raised or reduced. Real interest rates, the nominal rate less the rate of inflation or plus the rate of deflation, cannot be reduced once the nominal rate is down to zero. Britain has never tried a mechanism to apply a negative nominal interest rate, when the depositor pays interest instead of receiving it. The Swiss Federal Government, by contrast, has on occasion ordered the application of negative nominal interest rates to foreigners’ deposits. If deflation is running at five per cent, then even if the nominal rate of interest is zero, the real (deflation-adjusted) rate of interest is also five per cent. The lowest nominal rate of interest ever charged in Britain by the Bank of England is two per cent. This may well be the lowest practicable level for Bank Rate, though the Japanese have taken their discount to zero.

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