Negative U.S. rates? “Simply not a good idea.”

March 11, 2016

Federal Reserve Chair Janet Yellen smiles at the Federal Reserve's ninth biennial Community Development Research Conference focusing on economic mobility in Washington April 2, 2015. More research is needed to understand what policies allow people to move up the economic ladder and what holds them back, Yellen said on Thursday, returning to a controversial topic for the U.S. central bank. REUTERS/Yuri Gripas - RTR4VVN7

Whatever the pros and cons of negative rates, turned into official policy by five major central banks around the world, the chances of the U.S. Federal Reserve following suit are apparently minuscule.

That’s the majority view from around 50 economists polled by Reuters this week, who gave a median 5 percent likelihood of the Fed deploying negative interest rates.

Only three in the sample gave a probability of one in four or higher.

As Donald Ratajczak, an independent economist, put it:

Insanity may be contagious but I believe our Fed knows the long-term risks of such a policy.

For now, Fed Chair Janet Yellen is more concerned about inflation picking up in an economy with unemployment now below 5 percent and is pondering when next to raise rates.

European Central Bank President Mario Draghi, facing no inflation at all and joblessness still more than double that, apparently is not worried about the long-term risks from taking rates even further in the opposite direction.

The ECB slashed its deposit rate to -0.4 percent on Thursday, the fourth such 10 basis point cut since June 2014, and ramped up its monthly purchases of government bonds to 80 billion, which amounts roughly to 1.7 billion euros a minute.

It even went so far as offering to pay banks that borrow from it so long as they lend it on to businesses and consumers.

While the rationale for sub-zero deposit rates is they deter banks from hoarding cash with the central bank and encourage lending, there is little evidence the policy has helped to boost credit growth significantly.

In the euro zone, for example, lending to corporations rose just 0.6 percent in the year to February, even though the ECB first cut its deposit rate to negative over 1-1/2 years ago. At its peak, just before the financial crisis, euro zone credit growth was over 10 percent.

Negative rates have also not had any influence on exchange rates.

While they won’t say so, central banks implementing such a policy would be happy if their currency weakens, because it helps boost imported inflation, at least in theory.

The Bank of Japan has spent most of the past decade printing trillions of yen, buying everything from government bonds to equity index funds, in the hope of weakening the currency and boosting inflation.

But the yen is up over 5 percent against the dollar so far this year, after briefly falling on surprise news from the central bank it was introducing negative rates.

And while the euro fell 1.6 percent after ECB President Mario Draghi announced the latest deposit rate cut and barrage of other stimulus measures on Thursday, it soon surged to a three-week high against the dollar. The euro is up 1 percent so far this year.

Inflation is also nowhere to be found in Japan or the euro zone.

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Negative rates have been most criticised for dragging on commercial banks’s profits. Banks have had to absorb the higher cost of funds without being able to pass it on to their customers. Morgan Stanley last month estimated any further moves into negative interest rates by the ECB could erode euro zone bank profits between 5 to 10 percent.

The other consequence, critics point out, is that negative rates usually drag long-term sovereign bond yields close to or below zero — a disincentive to bond investors.

That, they argue, works against their overall intent by causing future inflation expectations to fall as well.

Russell Price, senior economist at Ameriprise Financial says of negative rates:

The evidence from Japan and Europe suggests that it does not work.

Given relatively elevated debt levels, enticing even higher credit balances is not logical. Fed should look at the other side of the equation by allow economic activity and inflation to run a bit hot over the intermediate-term.

Over time this should allow them to successfully raise the Fed Funds rate into economic strength without consistently threatening deflation.

Hugh Johnson, independent economist:

Simply not a good idea.

William Dickens, economics professor, Northeastern University:

It would require a very serious recession — possibly a panic — before they would do that. The FOMC (Federal Open Market Committee) seems to be dead-set against such a policy. If they weren’t, they would have used it early in the recovery.

Terry Sheehan, economist at Stone & McCarthy Research Associates:

We think the consequences of negative interest rate policy for the U.S. would be far riskier than the benefits. While it is entirely appropriate for the Fed to explore how these would work as a tool of monetary policy, it is one we think should be low on the list of options.

 

— with reporting by Hari Kishan

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