The case against negative rates for the US

By Steven Knight, Research Analyst, Blackwell Global The past few weeks have seen mounting speculation doing the rounds that the US Federal Reserve could potentially be contingency planning for the introduction of a negative interest rate policy (NIRP). Given the historically low Federal Funds Rate, and the lack of available monetary policy tools, NIRP might […]

By Steven Knight, Research Analyst, Blackwell Global

The past few weeks have seen mounting speculation doing the rounds that the US Federal Reserve could potentially be contingency planning for the introduction of a negative interest rate policy (NIRP). Given the historically low Federal Funds Rate, and the lack of available monetary policy tools, NIRP might seem the obvious choice in responding to a recession. However, there are some serious questions regarding the effectiveness of introducing a “tax” on banking.

Obviously, negative interest rates have been at the forefront of debate over the past month given their introduction in Japan, as well as some concerning rhetoric from the US Fed regarding the “legality” of their use within the economy. In fact, given the expectation setting by both the Fed’s Kocherlakota and Kashkari, it is highly likely that NIRP currently forms part of the central banks response if a recession was to become apparent. Subsequently, a robust discussion of breaching the zero lower bound as a stimulative tool is highly appropriate.

Firstly, it is important to note that negative interest rates are a relatively new tool in the monetary policy tool bag for central banks. Although the Swedish Central Bank was the first to introduce them in 2009, their ultimate effectiveness is arguable. The introduction of negative rates, albeit at a wholesale level, is largely seen as a tax on the holding of money. The intent was to dis-incentivise the hoarding of capital by financial institutions and to stimulate lending and credit growth.

Chart

However, the jury is largely still out on the overall effectiveness of the NIRP policy, especially when you consider the sagging GDP growth in both the Eurozone and Japan, both of whom have undertaken negative rate campaigns. Subsequently, there is likely to be a bevy of PhD dissertations in the next ten years targeting both NIRP and QE.

One of the inherent risks of NIRP policies is the passing of these costs through the pass-through channels to consumers. Although this doesn’t appear to have directly occurred, as far as retail rates, it is highly likely that banks have found ways to defray the expense through additional fees on accounts and services. Subsequently, there is a long-term concern as to whether this incentivises the move back towards physical currency and would lead to consumer withdrawals rather than simply an increase in spending, consumption, and investment.

In addition, in a globalised world, capital typically flows to where yields are present and NIRP policies actually incentivise capital outflows to other markets.

Point in case, prior to the recent Fed rate hike, global currency markets were beset by capital seeking the widening interest rate differentials in other currencies such as the NZD and AUD (known as a carry trade). Subsequently, these markets were somewhat distorted as injected capital effectively found its way offshore to where the yields were present, thereby artificially increasing exchange rates and demand for those pairs. This has clearly also had an impact on the export trade demand for many economies, especially given the large swings within valuations.

Additionally, NIRP imposes some additional reporting and forecasting problems for Central Banks. Much of the current framework for predicting and forecasting the economy largely relies upon econometric models that assume a relationship between money, interest rates, savings, and investment. Unfortunately, when you upset the apple cart with negative rates, it changes many of these relationships and the econometric forecasting models start to break down.

In fact, NIRP and QE may explain why we have seen a move away from the use of the Taylor rule and Phillips Curve amongst some central banks. This ultimately leads to a risk of increased timing errors by the very institutions that were meant to be stimulating growth a price stability.

Although, many would consider that consumers purchasing power has already largely been eroded by inflation over the past few years NIRP could be the ultimate double whammy as they lose their purchasing power in real terms, along with having a form of increased fees/costs to hold money foist upon them. This could lead to some significant changes in how consumers perceive digital and physical currency, which is a slippery slope indeed.
Ultimately, I suspect that central banks will learn that there is a limit to the effectiveness of their monetary policy and management of the economy. It begs the question, at what point should fiscal policy step up and be used to buoy an economy and smooth out the business cycle. I suspect that the answer to that question is that the economy should look towards Fiscal policy when rates reach the zero-lower-bound, lest large distortions in financial markets and the velocity of money are to occur.

Read this next

Executive Moves

Crculus taps Michael Idzkowski as head of sales

Michael Idzkowski has joined Crculus, a UK-based startup that describes itself as a multi-custody middleware infrastructure for financial institutions, in the post of its head of sales.

Retail FX

ActivTrades jumps on fractional stock trading bandwagon

CFDs and FX broker, ActivTrades has updated its trading offering to provide its clients with the opportunity to trade fractions of stocks.

Digital Assets

BitMEX to list its native token by end of 2023

BitMEX CEO Alexander Hoeptner said the crypto exchange is planning to list its native token, called BMEX, on the spot market by the end of the year.

Market News

Forex investments take over popular sentiment as a worthy global trend

Quite the confusion is afoot in the financial markets. Tighter regulation, rising inflation, energy sector disruptions, social unrest and wars have taken a toll on the world’s economies. How come Forex, as a means of investment, has come up on top as a global trend in 2022? Against the backdrop of current events, the international broker’s expert team at OctaFX has gathered some answers.

Crypto Insider, Metaverse Gaming NFT

How Hiding Crypto’s Influence Will Be Key To Unlocking Its Success

In past years, cryptocurrency has advanced well beyond the technophiles responsible for its initial success to reach widespread name recognition. Crypto has found its way into news, music, culture, and other relevant facets of daily life. 

Digital Assets

SCRYPT Digital taps Enclave Markets to mirror dark pool trading in crypto

“A service like this has been sorely lacking in the crypto space. There hasn’t been a solution that provides the security or privacy that institutions require with these kinds of trades.”

Institutional FX

FXSpotStream reports record monthly volume at $1.613 trillion

Trading volumes on institutional FX platforms surged in September after fears over the impact of recent developments around Russia’s military invasion of Ukraine sent speculative asset classes reeling.

Industry News

OKX adds four-time Olympian snowboarder Scotty James as brand ambassador

‘What is OKX?’ is the name of the new multi-milion dollar brand campaign launched by crypto exchange OKX as part of its efforts toward world expansion.

Industry News

Circle buys Elements and announces beta version of Crypto Payments API

“Lowering barriers of entry for payments and financial services and establishing dollar payments utility are core to Circle’s mission.”

<