The Real Problem With Negative Rates

The European Central Bank has just confirmed that negative interest rates will remain in place at least for the rest of this year, and potentially much longer. That may upset investors, who have long queried whether negative rates do more harm than good because of the collateral damage to the banking system. It’s true that keeping rates too low for too long could be counterproductive. But the real problem with the status quo is not the one that the market tends to focus upon.

Obviously the ECB has created a lot of cash in the process of buying trillions of bonds over the past five years. The banking sector is paying billions each year in negative interest on those cash balances. The ECB could reduce this direct cost without necessarily diluting the impact of the stimulus by applying the negative rate to only a fraction of the excess cash in the system. However, this is something of a side issue.