Negative Rates May Be Ineffective and Dangerous
... according to the Bank for International Settlements (BIS) — the so-called central banks' central bank. The BIS has just released a research report questioning whether negative interest rates are effective in achieving policymakers' goals of staving off a (phantom) deflation without adversely impacting the financial sector and the overall economy. So far banks in countries with negative rates (Japan, Sweden, Denmark, Switzerland, and the eurozone) have not passed on negative rates to their retail depositors or borrowers, so they have been largely ineffective in spurring increased spending. When the Bank of Japan unexpectedly announced that it was moving rates into negative territory, the yen stopped appreciating for a few days but then began to rise again and, in the weeks since, the Japanese stock and currency markets have been in turmoil. Also, as the BIS researchers note, some mortgage rates in Switzerland have "perversely increased" after the policy rate dipped into negative territory.
More worrisome for the BIS researchers are the potential effects when negative rates are passed on to bank borrowers and retail depositors. As the researchers conclude:
If negative policy rates do not feed into lending rates for households and firms, they largely lose their rationale. On the other hand, if negative policy rates are transmitted to lending rates for firms and households, then there will be knock-on effects on bank profitability unless negative rates are also imposed on deposits, raising questions as to the stability of the retail deposit base. In either case, the viability of banks’ business model as financial intermediaries may be brought into question. ... Even more directly, such rates can weaken the profitability and/or soundness of institutions with long-duration liabilities, such as insurance companies and pension funds, seriously challenging their business models.
So if banks simply do nothing and maintain deposit and lending rates in positive territory, negative rates have little effect on the economy. If banks do begin to pass negative interest rates forward by in effect paying households and firms to borrow money, their profitability and that of other financial institutions will suffer; but if they try to lower their costs by passing them backward by charging depositors to hold their funds, there will be a mass exodus of deposits. Indeed, preventing the latter occurrence is the main rationale for the increasingly hysterical War on Cash, with Larry Summers recently calling for a ban on high denomination bills worth more than $50 or $100 and Sweden planning to phase out the new bank notes introduced just last year within the next five years.
Fortunately — although much to the chagrin of governments and macroeconomists — ordinary people are not sitting idly by and waiting for the imposition of negative deposit rates and the inevitable unraveling of the experiment with "unconventional" monetary policy. They have begun to resort to the trusty old standby of hoarding cash to preserve their property and wealth. In Switzerland, the circulation of 1,000-franc notes, which are worth about $1,010, increased 17 percent last year and now account for 60 percent of the bills in circulation. Japan experienced a 6.2 percent increase of 10,000-yen notes, which was the largest annual increase since 2002. The fact that these notes are only worth $88.00 and are therefore difficult to store accounts for the recent run on safes in Japan. Some stores reported that sales of safes exploded by 250 percent last month after the Bank of Japan announced it would pay negative rates on some bank reserves.