Negative Interest Rates

Where Is the Real Limit to Cheap Money?

At some point along your life journey someone has probably given you a nugget of financial wisdom like ‘make sure you put some money in the bank for a rainy day”. Even the magazines at the supermarket checkout have articles on personal finance with flashy titles giving advice on ‘how to make your money work for you’. Both advocate gaining interest on your cash in a bank as opposed to stuffing it under your mattress. Usually it’s pretty sound advice, but it is based on the assumption that the bank wants to hold your money and will pay you interest to do so. But what if that’s not the case? What if interest rates fall and keep falling until they’re below zero? Would you save your money in a bank if you had to pay them instead of them paying you?

In an effort to stimulate the economy post the Great Financial Crisis, five major central banks have experimented with negative interest rates. In practice this means they’ve lowered their policy rates to a point at or below zero such that banks who want to park their excess cash at the central bank have to pay a fee instead of receiving interest. The theory is that if it’s unattractive for banks to park their money, they’ll lend it instead. Same for consumers. If they’re faced with paying a fee to store their money in the bank versus borrowing money at no cost, they hopefully will take the money and spend it in the economy.

Interest across the globe on using negative rates as a policy tool has increased with global interest rates moving towards zero in the hopes of pulling economies quickly out of the current COVID-19 recession. In the report that follows, we look at what the positives are of negative rates in terms of whether they boosted credit growth, stimulate spending, or contribute to currency weakness. More importantly, we explore the potential side effects negative rates have had on corporates, households, banks, pensions, and markets.

Central banks like to describe the limits to ever easier monetary policy in terms of technical hurdles to be overcome. If banks can be protected, cash hoarding prevented, and inflation is nowhere to be seen, surely they should keep on pushing?

But the real limits to monetary policy lie not with some technocratic quantitative assessment of the benefits relative to the side effects. They revolve around whether fueling increased credit growth and ever higher asset prices is always beneficial, even when financial conditions are extremely easy in the first place. The real limits in practice are likely to be reached long before the technical ones.