Last week, the Hutchins Center On Fiscal And Monetary Policy, part of the famous Brookings Institution, conducted a conference on the effectiveness of negative interest rates. The interactive workshop heard from, and reviewed, the execution and results of having a negative interest rate policy (NIRP) of five central banks. At present, there are 12 countries that have negative rates somewhere in their yield curve. The chart below outlines those countries. The world has never seen this type of coordinated negative interest rates for this period of time so if you are a student of economics at any level, this is fascinating information, particularly when you consider we are potentially just one recession away here in the U.S.
While the complete video and materials can be found HERE, we present a short recap below.
Deposits: One major characteristic of NIRP, to date, was to construction the policies so that it would not impact the retail depositor. Thus, while financial institutions and some corporate depositor may face negative effective rates (net of fees), it has been a construct to try not to impact households.
Risk & Impact: Of course, all parties have been impacted by NIRP. Insurance companies, pensions and asset managers, in particular, have adjusted so households are impacted. Insurance companies have required more premiums and have returned less on annuities and similar investments. In addition, even if there is not an impact fiscally, money runners have been forced to increase risk to the extent their policies allow, through interest rate, credit or liquidity in order to obtain some form of yield. Further, and almost more importantly, NIRP has forced money into various economic corners resulting in an increase in asset prices – a very palpable form of risk. A common theme of the conference was “NIRP is very efficient way to make safe assets expensive.”
Methodology: Not all NIRP is the same. The conference was fantastic at highlighting the differences between what is going on in Japan versus the Riksbank. For some, NIRP is a primary monetary tool, for others, it is more of a mechanism for fine tuning. Switzerland and Denmark, as an example, is hyper-controlling the level of currency, which is turning out to be a decent move to prevent hoarding, major commercial bank net interest margin compression and runaway asset bubbles.
Education & Fear: NIRP is a potentially powerful tool but one that was found to strike fear in the public and politicians due to lack of understanding. NIRP’s efficacy is constantly being questioned in relationship to other tools such as quantitative easing.
Lowest of Bounds: Every time NIRP is used, the question arises how far negative a central bank can go before problems such as currency hoarding, destruction of money markets and damage to the banking system is material and counterproductive. A common theme was that the banks that are using NIRP now, are close to this lower bounds threshold. The key thought for bankers to contemplate – could more negative rates be more safely obtained if you didn’t have to worry about physical currency? That is, would electronic currencies help mitigate lower bounds damage? Could a punitive cash-to-deposit exchange rate be introduced within a given currency to also counteract lower bounds problems?
Exit Strategy: Ironically, the most important topic (in our mind) was not covered – When an economy needs to reverse NIRP, how does a central bank do it? It is not as easy as it might seem, particularly in inter-related major economies where a country’s currency could get potentially get hurt in the process of reversal.
NIRP In The US: Ex-Fed Chair Bernanke led a discussion along the lines of his previous blog posts saying that NIRP would only be used in the extremist of circumstances here in the US. There are some characteristics that are unique to the US that limit NIRP’s effectiveness relative to quantitative easing.
Submitted by Chris Nichols on June 14, 2016