By Greg Ip
Interest rates can't go below zero--or so says a longstanding
rule of economics.
Savers would sooner hold cash, goes the logic, than lose money
leaving it in the bank. Economists call this presumed floor the
"zero bound." It's why many central banks, having cut rates to
zero, have tried to revive growth with more-exotic tools, such as
massive purchases of government bonds.
But as with so many other rules in recent years, the zero bound
is being rethought as central banks push rates into negative
territory to revive their slowing economies. The big question is
whether this new monetary tool will be enough to resuscitate
spending and push inflation back up in the many parts of the world
where it's sagging.
Sweden led the way below zero for a brief time in 2009 and 2010,
followed by Denmark from 2012 to 2014. Last year, the European
Central Bank introduced a negative interest rate. Largely in
response, Switzerland and Denmark have since pushed a key policy
rate to minus 0.75% and Sweden to minus 0.85%, unprecedented in
modern times.
Individual savers have mostly been spared, but big customers
aren't so lucky: Some German banks are charging for large deposits,
and in the U.S., J.P. Morgan Chase will do the same, though the
Federal Reserve has stayed on the positive side of zero and looks
set to raise rates this year. About 16% of the world's government
bonds now sport negative yields, meaning investors are paying to
lend to those governments.
This is a potential game-changer for central banks. Normally,
they stimulate spending by lowering the real interest rate, that
is, the nominal interest rate minus inflation. With inflation now
close to zero or lower in many countries, negative nominal rates
make possible more negative real rates.
Interest rates are normally positive because it suits both
savers and borrowers. It provides households with an incentive to
save for tomorrow rather than spend their money today. Companies,
meanwhile, are willing to pay to borrow because they plow the money
into projects that promise higher returns.
These relationships, however, are not immutable. Worry over the
future can drive people and companies to stash money away even if
they receive nothing in return. Companies can have such low
expectations about the viability of new projects that only zero or
negative rates can entice them to borrow and expand. That seems to
be the case now. Central banks have held real rates in negative
territory since 2008 because of the moribund investment environment
and very low inflation.
Historically, however, central banks have almost never pushed
rates below zero. First, it wasn't needed. Second, it might disrupt
the financial system; For example, money-market mutual funds would
close up shop if they couldn't promise investors a positive return.
Third, it could push depositors to simply take their money out as
cash.
Europe's experience has eased some of those worries. The Danish
central bank found that after rates went negative in 2012, the
money market continued to function normally, and there was no surge
in demand for large-denomination krone notes. Rates today in
Sweden, Denmark and Switzerland are more negative than they were in
Denmark in 2012, yet none has yet seen a surge in currency
demand.
There are several reasons why. Thanks to debit cards, online
payments and smartphone wallets, physical cash has become
relatively more burdensome and costly. An ECB study found cash 11
times as costly as checks for handling most transactions. In
digitally savvy Sweden, currency in circulation has fallen by about
25% since 2009.
Moreover, small savers for the most part haven't been hit. For
big savers such as banks and investment funds, transporting and
storing hundreds of millions of euros, dollars or francs, not to
mention complying with anti-money-laundering laws, is expensive and
time-consuming.
This all suggests the zero bound binds less than central bankers
once thought. How much of a difference this makes depends on what
they are trying to achieve. Denmark's goal is to keep the krone
pegged to the euro. Negative rates have accomplished this by
deterring inflows of so-called hot money from foreign investors,
which might push the krone up. The prospect of losing money on a
super-safe government bond could be a powerful psychological spur
driving money into stocks and commodities.
But what central banks would prefer is that households and firms
spend more, and a barely negative interest rate is only a bit more
of a stimulus than a rate of zero.
Getting a bigger bump may require a deeper dive into the
negative, which would force banks to charge individual depositors,
who would howl.
And at some point, a negative enough interest rate makes the
hassles of handling millions of dollars of cash worthwhile.
Someone, for example, could create an exchange-traded fund that
invests in paper currency as an alternative to bank deposits. To
deter such behavior would require phasing out paper currency, as
Harvard's Kenneth Rogoff has suggested, or taxing it, an idea first
put forward a century ago by Silvio Gesell, a German businessman
and economist.
That sounds sensible to economists but reprehensible to the
public, which is why it won't happen. There's still a boundary
below which rates cannot go, even if it's no longer zero.
Write to Greg Ip at greg.ip@wsj.com
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