Negative Rates Veteran Still Searching for the Lower Bound

  • Danish central bank governor says monetary policy has limits
  • Lars Rohde says Danish banks profitable despite negative rates

Negative interest rates work best when they are focused on a "simple goal" and can’t be expected to solve the broader weaknesses of an economy, the man who is now in charge of the first central bank to go below zero warned.

“One should acknowledge that monetary policy has supported growth and inflation to a large degree," Danish central bank governor Lars Rohde said. "But there may currently be important factors keeping overall demand, and thereby inflation, down and there are limits for the impact of monetary policy in general."

The DCB -- or Danmarks Nationalbank -- first cut its policy rate below zero in July 2012 in a bid to fulfill its sole mandate, which is to defend the krone’s peg to the euro. The benchmark rate is now at minus 0.65 percent and economists don’t see it returning above zero before the end of 2018 at the earliest.

Denmark’s economy is one fortieth the size of the neighboring euro area, making it highly dependent on what happens in Berlin, Paris or Rome. But its experience with negative rates may prove instructive in Frankfurt. At its next policy decision on March 10, the European Central Bank may respond to weakening inflation expectations with a further cut to its deposit rate and even an increase in the pace of quantitative easing.

Economists are split on how the Danish central bank would react, with some noting that the krone is now comfortably within the peg.

The ECB, the Swiss central bank, Sweden’s Riksbank and, since January, the Bank of Japan are all experimenting with negative rates in a bid to boost consumer prices in an era of slowing global growth.

Cash Costs

In an interview Sunday on the edges of a meeting of global financial officials in Shanghai, Rohde said that while it’s now clear that the lower bound for central bank policy rates is no longer zero, the depth at which it actually lies will depend on many factors, among them the public’s preference for using cash. 

Negative-rate theorists have long fretted that the policy will fail as soon as banks and the public start swapping deposits with banknotes. But Rohde said the Danish experience shows that "cash isn’t costless."

“What we didn’t know was where the boundary is, and the good news is that we haven’t found it,” Rohde said. “We haven’t seen any unusual rise in outstanding notes, the system is working the way we expected. Basically, it’s not different from having a low positive interest rate.”

That said, Rohde warned that the longer-term impact of negative rates on the banking system and its profitability must be borne in mind. From the first use of a negative deposit rate, Denmark implemented a threshold for banks’ excess funds and required that they only pay the negative rate above that line. That didn’t diminish the effectiveness of the policy but meant bank profitability didn’t suffer unduly, he said.

Such a two-tier system is only now under consideration at the ECB, even though a negative deposit rate there has been in place since June 2014.

“If you want to avoid having a big impact on the profitability of the banking system, that is a possible way to do it,” Rohde said. “Last year the Danish banking system had its most profitable year since 2008.”

Speculators Warned

With Denmark viewed by some investors as a haven and by others as a target for speculation against its currency peg, the country could face another wave of capital inflows should the ECB ease significantly. Rohde said the bank has what it needs to fend off upward pressure on the currency.

“One should be aware, if you are trying to speculate against us, that we have unlimited access to Danish krone,” he said. “We are quite confident that we would be able to handle a new wave, if some central banks around the world go even lower. We have a lot of instruments in our toolkit and we will use them.”

Yet Rohde finds himself in the same conundrum as many of his global colleagues: Knowing that central banks have come almost to the edge of their capacity to manage inflation and growth, while being aware that even more could soon be asked of them. That provided a theme for policy makers at the Group of 20 meetings in Shanghai at the weekend, which agreed more emphasis on fiscal support and structural reform is needed.

“I think we can say now that monetary policy globally is a little bit overstretched,” he said. “Basically, there should be more support from other policy areas.”

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