Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, the European Central Bank has cut a key interest rate below zero, the first major central bank to venture into negative territory. It’s one way to try to reinvigorate an economy with other options exhausted. It’s an unorthodox choice that the U.S. Federal Reserve and other peers have so far rejected.
ECB officials say more stimulus is needed to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery. The bank cut its deposit rate to minus 0.1 percent from zero on June 5 and reduced its benchmark interest rate to a record-low 0.15 percent. A deposit rate below zero effectively punishes banks that have extra cash but are reluctant to extend loans to weaker lenders. The economy is grappling with a shortage of credit and unemployment near its highest level since the currency bloc was formed in 1999. The ECB has particular reason to use negative interest rates. The Fed and the Bank of Japan have turned to large-scale 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, though it is offering more liquidity to banks and will start work on plans to purchase asset-backed securities.
With interest rates at all of the world’s major central banks effectively at bottom, officials 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 — and ended the policy in April. There is no guarantee that negative rates will be able to revive an entire economy or work in one as large as the euro area. During the height of Europe’s sovereign debt crisis almost two years 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, thus also 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 Fed chair, 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.
The Reference Shelf
- Blog posts from Francesco Papadia, a former director general for market operations at the ECB, on whether the central bank should have negative rates, and a discussion about where rates could go.
- A May, 2014 interview with Peter Praet, a member of the ECB’s executive board on policy options published in Die Zeit.
- 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.