When Nothing Else Works – Lower Interest Rates?
– Momentum Public Relations –
Negative interest rate policy (NIRP) is going mainstream. At the very least, active discussion of the possibility of NIRPs by senior level financial strategists has gone mainstream.
A few years ago anyone who suggested that central banks would be forced to consider this kind of policy might have been dismissed as a prophet of doom. Often, with twenty-twenty hindsight, yesterday’s prophet of doom morphs into today’s “expert”. But predictions related to capital markets are notoriously challenging given the multitude of variables. The near-term health, and the medium-term growth prospects, of developed economies continue to baffle the most astute prognosticators and trend watchers.
Janet Yellen, the current Chair of the Board of the US Federal Reserve, in her Senate confirmation hearing in late 2013, suggested that if interest rates approached zero that it could become quite disruptive to the money markets that feed the banking industry. The economic challenges of 2014 and 2015 have continued to place downward pressure on interest rates, notwithstanding Ms. Yellen’s concerns.
NIRPs have been used in recent years, but on a limited basis, and often for very specific reasons. In many cases, the purpose was primarily intended to discourage an influx of foreign money. They have also been used as a tool by some countries to peg the value of their currency to a larger currency. Today, the central banks of the Eurozone, Denmark, Sweden, Switzerland, and Japan are using NIRPs to attempt to manage the money supply and encourage investment in enterprises that produce discernible economic activity. The merits and potential impact of a NIRP is generating considerable debate in the financial press.
http://www.bloombergview.com/quicktake/negative-interest-rates
The larger economies of the world continue to face sluggish demand. Commodity prices are at a low point. Economic recovery post-2008 has slowed to a crawl. Anemic economic growth has had an impact on how most banks view risk. Already chastened by the excesses of the past decade, they have no desire to head out into uncharted waters. Recently, the overall cost of borrowing has been low, but the demand for money has been weak. This has caused some financial institutions to park money, holding it rather than lending it. The same has been true for a variety of investors. If stocks continue to be volatile then, in theory, it makes sense to preserve capital and liquidity by putting it in low or no-interest accounts. If an institution, or an individual, is faced with negative interest rates that means they have to pay a price to maintain their stash of cash. So what should cautious investors do and how can capital be protected? Will negative interest rates cause people to put their money under their mattresses?
The principle of NIRPs is that those who place something in storage have to pay for the privilege of storing it. The main reason for the policy is weak demand. When lenders cannot obtain a sizeable enough return on a loan, then they cannot afford to pay interest on the money that they are using to provide the loan. In theory, NIRPs ought to encourage investors to move money out of savings and into in the working economy. The policy also offers a disincentive for financial institutions to keep money in their vaults. When interest rates are negative, a retail bank has to pay the central bank if they wish to hold money in an account with the central bank. Additionally, an investor will be faced with a negative yield on bonds that previously returned additional cash at maturity, and a pensioner will have to pay a local retail bank to keep her money in a savings account.
The question is; will NIRPs spur real investment and produce economic growth? Does such a policy represent the last lever of economic influence that a central bank can use?
The answer is stay tuned. The evidence isn’t conclusive. Major central banks that have migrated to NIRPs have not yet produced much in the way of discernible stimulus. However it is impossible to assess if, in places like the Eurozone, NIRPs have prevented further deterioration of the regional economy.
The Fed in the United States has sent signals that suggest that an NIRP is on their agenda. Their position on the issue hasn’t formally changed, but we know how the Fed works. The fact that they speak openly about it and that they are running simulations through economic models suggests that a NIRP must be on the table for consideration. The Bank of Canada has sent similar signals while declaring its preference for maintaining the status quo, an extremely low-interest-rate that is as close to zero as possible.
One important takeaway for investors is that a policy that wasn’t being seriously considered a short time ago is being assessed by virtually every major central bank. When nothing else works, perhaps it is a policy worth considering.