Lessons for Draghi From a Land of Sub-Zero Interest Rates

  • Denmark has had mostly negative interest rates since mid-2012
  • Main effects have been higher asset prices, not growth

Until not so long ago, the idea of sub-zero interest rates was about as far-fetched as the prospect of a brash real estate tycoon running for U.S. president.

QuickTake Less Than Zero

These days, the discussion is whether a deposit rate below minus 0.20 percent is a good trump card to play when dealing with Europe’s sclerotic economy.

The European Central Bank meets on Thursday for yet another discussion on how to stimulate growth. Rate cuts are improbable -- ECB board member Benoit Coeure recently described the current level as "the effective lower bound."

Should ECB President Mario Draghi and his colleagues nevertheless opt to discuss the matter, they might consider taking this lesson from Denmark: negative rates don’t provide a quick fix.

The Danish central bank, whose sole mandate is to guard the krone’s peg to the euro, first cut rates below zero in mid-2012, when investors were looking for havens at the height of Europe’s debt crisis. The key deposit rate, now minus 0.75 percent, has been mostly negative since then. Economists recently surveyed by Bloomberg see negative rates continuing into 2017. That’s not necessarily because they expect rates to rise after that, but because their models just don’t go any further.

The good news

One of the key lessons from Denmark is that banks are reluctant to charge customers for holding their money. While some have raised fees, "real rates for real people were actually never negative,” says Jesper Rangvid, a professor of finance at the Copenhagen Business School.

For that reason, Danes haven’t been hoarding cash. According to Rangvid, rates would have to drop as low as minus 10 percent before people start "building their own vaults." Experiences in Switzerland and Sweden tell a similar story.

The bad news

Economic theory says interest rates are inversely related to investment. People are also supposed to spend less when rates are high and spend more when they’re low. Because interest rates determine the value of cash today, they have been described as "a tax on holding money" and "the price of impatience."

And yet, Danes have actually been squirreling away. According to central bank data, Danish households’ have added 28 billion kroner ($4.3 billion) to bank deposits since rates shrank to their record low on Feb. 5.

Danish businesses, meanwhile, have barely increased their investments, adding less than 6 percent in the 12 quarters since Denmark’s policy rate turned negative for the first time. At a growth rate of 5 percent over the period, private consumption has been similarly muted.

Why is that? Simply put, a weak economy makes interest rates a less powerful tool than central bankers would like.

"If you’re very busy worrying about the economy and your job, you don’t care very much what the exact rate is on your car loan," says Torsten Slok, Deutsche Bank’s chief international economist in New York.

The Danish experience, it seems, lends credence to Nobel laureate Paul Krugman’s argument that "monetary policy loses its effectiveness, especially when rates are close to zero."

Risky business

If negative rates don’t spur growth -- Danish inflation since 2012 has been negligible and GDP growth anemic -- what are they good for? Where do you invest your money when rates are below zero?

The Danish experience says equities and the property market.

The benchmark index of Denmark’s 20 most-traded stocks has soared more than 100 percent since the second quarter of 2012, which is just before the central bank resorted to negative rates. That’s more than twice the stock-price gains of the Stoxx Europe 600 and Dow Jones Industrial Average over the period. Danish house prices have jumped so much that Danske Bank A/S, Denmark’s biggest lender, says Copenhagen is fast becoming Scandinavia’s riskiest property market.

As Slok put it, negative rates "raise risks in the short term and do little to help the economy than what can be achieved with bond purchases.”

But Draghi probably already knows that.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE