Imagine a bank that paid negative interest. Depositors would actually be charged to keep their money in an account. Crazy as it sounds, officials at the European Central Bank say they’re considering cutting rates to less than zero. In the world of central banking this is within the realm of possibility, one way to reinvigorate the economy with other options exhausted. It’s an unorthodox choice that the U.S. Federal Reserve and other peers have so far rejected.
The ECB has particular reason to consider negative interest rates. The Fed and the Bank of Japan have turned to asset purchases, known as quantitative easing, that create new money to fuel the recovery. European Union rules make it politically difficult for the ECB to buy large volumes of government bonds and its program for this is being reviewed by the EU’s highest court. The bank’s president, Mario Draghi, has been floating the idea of charging lenders to park their excess reserves at the ECB for more than a year. The rate on those deposits was cut to zero in 2012, the benchmark interest rate was reduced to a record low of 0.25 percent in November and banks are already offered unlimited access to funds. Cutting the deposit rate below zero would effectively punish banks that have extra cash but are reluctant to extend credit to weaker lenders. There’s also sluggish demand for loans in an economy where unemployment is stuck near its highest level since the currency bloc was formed in 1999. ECB officials and other policy makers around the globe say more stimulus may be needed to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery.
With interest rates at all of the world’s major central banks effectively at bottom, economists are looking again at what’s sometimes called the sacred “lower bound” of their main monetary policy tool. Negative deposit rates have been used by a handful of smaller central banks in recent years, including Sweden’s, which conducted a 14-month experiment in 2009-2010. Denmark moved below zero in July 2012, though the cut was aimed more at protecting its currency than stimulating growth. There is no guarantee the policy would work to revive an economy or on this larger scale. During the height of Europe’s sovereign debt crisis more than a year ago, Draghi pledged to do “whatever it takes” to save the area’s common currency, signaling the ECB’s willingness to experiment with monetary policy.
In theory, an interest rate below zero should lower all market rates, reducing borrowing costs for companies and households. In practice, though, there’s a risk that the policy might do more harm than good. Janet Yellen, the nominee for Fed chairman, said at her confirmation hearing Nov. 14 that the closer the deposit rate is to zero, the bigger the risk of disruption to the money markets that help fund banks. (The Fed pays 0.25 percent on excess reserves.) In Denmark, commercial banks didn’t pass on the negative rates to depositors for fear of losing customers. When banks absorb the costs themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend. One way to test the water: The ECB could make an unusually small cut for its first move into negative territory, pushing the deposit rate to minus 0.1 percent from zero.
The Reference Shelf
- A speech by Benoit Coeure, a member of the ECB Executive Board, on monetary policy and the challenges of the zero lower bound.
- A Bloomberg News article outlining the pros and cons of a deposit rate of zero or below and a QuickTake on the ECB’s options for some form of quantitative easing.
- An ECB research paper on non-standard monetary policy.
- A paper by Charles Goodhart, a former member of the Bank of England’s Monetary Policy Committee, arguing a negative rate on excess reserves would depress sovereign bond yields.
- Blog entry by Willem Buiter, chief economist at Citigroup Inc., on negative interest rates.