Have negative interest rates worked?

Negative interest rates have done little to stimulate growth where it was needed most, says Elliot Wilson. Now it’s time to find an alternative solution 

In decades to come, economists will look back on the current era, marked by low levels of economic and credit growth, quantitative easing (QE), and the advent of negative interest rates, and scratch their heads in wonder. 

The latter issue will surely render the greatest sense of perplexity. Negative interest rates are a curiously perverse phenomenon in that, rather than generating returns from central banks and commercial lenders, corporates and retail customers pay for the right to stash cash in their vaults. Superficially it makes no sense: if the key rate of interest is set at -0.2%, you pay two-tenths of a percent on your deposits, rather than generating a return on your reserves. 

A useful counterpoint to this is to imagine a landlord offering to pay a share of your rent. It’s an unlikely prospect. Yet this is where we find ourselves, nearly ten years on from the financial crisis. Sweden’s Riksbank’s key interest rate is -0.5%, and the Swiss National Bank’s rate is even higher (or lower, depending on how you look at it), at -0.75%, while the central banks of Europe and Japan charge a zero rate of interest. 
Why central banks used negative interest ratesThere is a perverse logic at work here – there usually is. The 2008 crisis led to a protracted period of low price growth and economic torpor that persists across much of the eurozone. Banks, weighed down by high debts and new regulatory costs, struggled to lend, while borrowers opted in the main to hoard cash rather than spending and investing. “The problem is a demand issue, not a supply issue,” says Kallum Pickering, chief UK economist at Hamburg-based Berenberg Bank. “If no one wants to borrow money, there’s not a lot that banks can really do.”

Central banks, keen to prevent their economies cratering, and wary of the perils of being sucked into a Japanese-style deflationary spiral, reacted post-crisis by opening the spigot (rolling out quantitative easing-style measures) and slashing interest rates. The European Central Bank (ECB) in June 2014 became the first major central bank to cut one of its key policy rates to negative territory. If the aim was to stimulate demand for credit, it didn’t work, particularly in the more indebted and subdued reaches of the continent. 

However, Paul Sheard, chief global economist at Standard & Poor’s, says central banks’ negative interest rate policy did work for one group – bond issuers – by helping to “push down bond yields, and therefore borrowing costs in the whole economy, across the entire yield curve”. But a key hitch was that by cutting rates to the bone, policymakers were making it hard for investors to winkle out viable, yield-bearing investment options. 

This is not a new problem. As Benoît Cœuré, a member of the ECB’s executive board, noted in a July 2016 speech, returns on safe assets have been declining in developed markets for years, due to demographic changes, a slowdown in the rate of technological progress, and high demand for assets relative to their supply. 
The consequences of negative interest ratesWith rates low across the West, it has become all but impossible to unearth a hidden gem – a low-risk security or government bond wielding a juicy rate of return. “Investors began to shy away from ‘normal’ investments, preferring to park their cash in anything with an upside,” notes Jonathan Watson, an associate director at UK-based FX broker Foreign Currency Direct. Funds and wealthy individuals bought property and shares, creating bubbles but doing little to generate genuine economic momentum. 

Major Western policy manoeuvres in fact did more to benefit the developing world, as investors went in search of yield in riskier but faster-growing economies. “With yield at a premium, capital was forced into lower-graded sovereigns or corporates, which proved a tremendous boon for emerging markets,” says Stuart Culverhouse, chief economist at frontier-market investment specialist Exotix Partners. “That demand helped keep yields in these [emerging] markets lower than they would otherwise have been.” 
"Once central banks cut their policy rates close to zero, the lesson should have been to rely much more on fiscal policy rather than eschew it" Former truisms have been upended, leaving policymakers and investors reeling. Negative or super-low interest rates have somehow succeeded in hurting both investors and savers. Larry Fink, CEO of global investment manager BlackRock, has warned that negative rates are “punishing” the world’s savers, noting that when interest rates are at, say, 2%, the average 35-year-old needs to save three times as much a year to pay for his retirement, than if rates were at 5%. 

Negative rates are hurting commercial lenders, which feel squeezed in both directions. On the one hand, sluggish growth and poor economic sentiment crimp loan demand. On the other, cumbersome new regulations have caused banks’ operating costs to skyrocket. “The costs involved in doing due diligence on a new client have increased sharply in recent years,” says Timothy Ash, head of CEEMEA desk strategy at Nomura. “So, you have the unfortunate situation where banks don’t want to do business with exactly the kind of corporate client that central banks desperately want banks to lend to.” It’s also widely argued that overregulation of financial markets has eroded many of the benefits that should, in theory, result from quantitative easing.
Alternative ways to stimulate growthThere is a growing feeling that central banks are struggling to find new ways of positively and directly influencing the economies they oversee. QE was tried in the US and UK, to mostly good effect, but only after central banks had cut rates to virtually zero levels, leaving them no choice but to expand their balance sheets artificially. The ECB then barrelled in, buying up trillions of euros worth of government and covered bonds and asset-backed securities. But it was late to the party, and its results have been mixed. 

Some governments have begun to ponder the benefits of so-called ‘helicopter money’, another unconventional stimulus tool that could involve printing money and handing it straight to the public, in the hope that they will spend it. There is, however, a growing feeling that central banks are “running out of road”, notes Watson. “If anyone had said ten years ago that we’d be here, no one would have believed them. Frankly, it’s all got a bit farcical.” 

Many increasingly believe that the conversation has quietly shifted, with central banks no longer viewed as vital to finding ways to end the nightmare of negative interest rates, and of cultivating new forms of economic output. “The Trump administration and the pro-Brexit campaigners in the US and UK may have their detractors, but they are focused on generating growth by cutting regulations and taxes,” notes Ash. “There is a sense that central banks have done pretty much all they can to re-stimulate growth.” 

Sheard adds: “The verdict on monetary policy in the past eight or so years since the financial crisis and the great recession is in, and it is that too much weight was placed on monetary policy and not enough weight was placed on expansionary fiscal policy in trying to stimulate economic activity. Once central banks cut their policy rates close to zero, the lesson should have been to rely much more on fiscal policy rather than eschew it and put monetary policy further and further into unconventional territory.”

Increasingly there is a sense of commercial, social and political – not to mention fiscal – urgency about the need to find new ways to stimulate credit and loan demand, and to bring interest rates out of the basement. “There are good reasons to believe that economies are not set up to deal with negative rates ad infinitum,” says Pickering. “When interest rates are in positive territory, businesses and consumers are borrowing, spending, and investing in the future.” 

Perhaps the biggest unanswered issue here is who should manage and oversee future financial crises. Will central banks ever be trusted again – or will politicians and consumers turn to other institutions in search of ways to banish the scourge of negative interest rates? Moreover, will the damage control be driven by human minds, or by a non-sentient mode of thinking, as we turn to conscious and collaborative algorithms in search of answers to the most complex of questions? It may come to that: surely robots cannot make a bigger pig’s ear of the past ten years of often well-meant-but-muddled financial thinking than the human race. 
Published: 22 Mar 2017
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