Negative Interest Rates
European central bankers have very recently announced that they are considering taking extreme actions to stimulate the region, including negative interest rates. When I first heard this, all I could think of was Europeans having to bring the bank a toaster to take their money. Those of you of a certain age will remember when U.S. banks used to give away things like steak knives and toasters for opening a new account. I once scored a small black and white TV this way. Individuals and businesses won’t have to pay the banks to keep their money on deposit. Rather, the way negative interest rates would actually work is that the central banks would charge member banks a penalty for having excess reserves on deposit. Presumably, this would induce the banks to make more loans to businesses and individuals, helping to reverse the troubling decline that has persisted for the past several years.
Why Do This?
As I mentioned in my last blog, Europe is getting dangerously close to deflation which would make it even more difficult to recover from their recent economic slump. The present situation is largely the result of excessive European reliance on fiscal austerity in recent years and somewhat hesitant stimulation through monetary policy. Putin’s annexation – or whatever you want to call it – of Crimea is ratcheting up economic uncertainty throughout the continent.
What it Means
Hopefully, negative interest rates and stepped up central bank purchases of government bonds (quantitative easing) would reduce European interest rates across the board. This should stimulate lending and borrowing. It should also weaken the euro vs. the U.S. dollar and other major currencies, thereby strengthening European exports. And higher prices for imports would help counter the deflation threat. As for the United States, I seriously doubt that we’ll be implementing negative interest rates anytime soon. Inflation is low, but unlike Europe, it is not getting lower and lower. Rather, the discussion here is all about the timing of the coming interest rate increases. When the Fed met in March, they surprised no one by announcing further “tapering” of the Quantitative Easing program. By late this year, they will probably stop purchasing securities altogether. Janet Yellen ruffled a few feathers during her inaugural press conference on March 19, when she replied to a question about timing by saying the Fed would probably start raising short-term interest rates roughly six months or so after ending the bond purchases. The financial types didn’t need to count on their fingers to figure out that this be as early as April or May of 2015 rather than later in the year as had been expected. Personally, I think they overreacted because what the Fed was really trying to say is that when they start raising short-term rates depends on a lot of considerations that include inflation and the labor market.
And her answer still puts higher short term interest rates a year or more away. Quite frankly, I rather liked it when I could get a new toaster at the bank every now and then …