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What You Need To Know About Negative Interest Rate Policy

| February 29, 2016
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The world’s central bankers are continuing to look for a way out of the global debt morass that continues to slow economic growth. Their latest iteration? You guessed it, NIRP, or Negative Interest Rate Policy.  Central banks may want to continue looking because this is not likely the way out.

What is NIRP? At the risk of making one’s head hurt, it is essentially when central banks (CBs) CHARGE DEPOSITORS, their member banks, for the PRIVILEGE of holding their deposits.  WOW!  By enacting such a policy, CBs aim to discourage the hoarding of safe assets (bank deposits) and to encourage these funds be lent out into the economy to be spent or invested thereby creating aggregate demand that propels the economy forward.  Japan was the latest developed nation to institute NIRP in an effort to combat deflationary pressures.  And this effort to suppress interest rates can be seen in government bond markets.  Bloomberg reports that today 29% of the developed world’s sovereign debt, totaling $7 TRILLION, yields less than nothing.  Global investors are now willing to PAY governments for the right to LOAN THEM MONEY.

NIRP may not be the magical elixir CBs believe it to be.  One of the unintended consequences of this policy has been to hamper the profitability of the banking system by reducing net interest margins.  This challenging environment, coupled with the fact that many of the European banks were not recapitalized to the extent the U.S. banks were after the Great Financial Crisis, creates significant pressure on these institutions.  And this pressure in turn causes investors to become skittish about buying or holding the stock or bonds of these institutions, further exacerbating the situation.

But extraordinary monetary policy often leads to even more extraordinary policy.  The thought being, if it hasn’t worked yet, it’s because we haven’t done enough of it.  Now discussions are turning to banning certain denominations of currency units, for instance the 500 Euro note.  Why?  The following excerpt from a Financial Times article by Gillian Tett entitled “The Benefits of Scrapping Cash” will explain.

“As rates turn negative, central bankers in places like Switzerland are scrambling to prevent consumers dashing into cash as this not only makes financial transactions less efficient but also makes monetary policy less effective.  After all, if people hold physical cash, which, unlike a bank account, is not directly affected by negative rates, the central bankers have less control.”

And control is the heart of the matter.  In these uncertain times, one thing appears fairly certain.  CBs will not relent in their efforts until they achieve their ultimate goal, inflation.  Let’s all hope they are not too successful. 

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