More and more central bankers have moved into the next frontier of monetary policy by enacting negative interest rates in an attempt to stimulate their economies.
Though the limited data available thus far make it difficult to judge the success or failure of this monetary innovation on an empirical basis, BlackRock Senior Director Peter Fisher turns to theory to point out this policy's inherent limitations.
During an interview on BloombergTV on Thursday, Fisher laid out the reasons why sub-zero interest rates will prove counterproductive by examining the three key channels through which monetary policy supports economic activity:
- Foreign exchange: a weaker currency helps improve net exports;
- Credit: lower borrowing costs spur more debt-fueled activity; and
- Wealth: monetary accommodation supports asset prices, and higher asset prices cause people to feel richer and boost their spending.
Fisher acknowledged that in certain cases—for smaller, open economies without especially deep capital markets (like Denmark or Sweden)—negative rates could prove to be a useful tool to deter capital inflows that foster an appreciation in the currency.
But this strategy doesn't work on a grander scale, according to Fisher, and has only helped weaken some exchange rates to a moderate degree thus far, because the U.S. still has a positive policy rate.
"But let's be clear, negative rates for the FX rate is about a race to the bottom of competitive devaluation," he asserted. "The International Monetary Fund was established to try to prevent us from doing that again, what we did in the 1920s and '30s that were such a disaster."
On the credit side, Fisher argues that policy wonks and central bankers alike have been too focused on just half of the ledger: the demand side.
While lower interest rates make it cheaper and more attractive for consumers to take on debt, net interest margins will determine how attractive it is for the lender to provide these funds.
Negative rates crimp profitability both by the direct charge on deposits and the flattening of the yield curve that has accompanied their adoption, he claimed. Banks have been unwilling to pass along the tax on deposits to their customers, due in part to the money illusion; the general unwillingness of people to accept a negative nominal return.
"How do you feel about lending more when the spread you're earning is compressing?" he said. "It's not about the level of rates, it's about the shape of the yield curve."
By lowering interest rates and, more recently, by engaging in large-scale asset purchases, central banks have helped support the value of risk assets. The traditional wealth effect holds that as the price of the assets savers hold rises, these people feel richer and spend more.
Negative rates, Fisher argues, are a perverse way of getting people to boost spending. If the tax on bank deposits is also levied on consumers, they're effectively made poorer by saving.
"If we put through a negative interest rate, and we pass it through to consumers, they'll stop saving and spend money," he said. "This is the opposite of the wealth effect!"
Fisher believes that central bankers' growing penchant for negative policy rates stems from a desire to avoid admitting that they've expended all of their monetary ammunition.