During the heart of the Great Recession in 2009, a traditional policy rule used as a informal guide by the Federal Reserve suggested that interest rates should be set below negative 5%.
But economists had long said that interest rates couldn’t go below zero.
To get around this “zero-lower-bound,” then Fed Chairman Ben Bernanke bought billions of dollars of securities and expanded the Fed’s balance sheet to spur low rates and risk-taking, in a policy known as quantitative easing. The move set off a fierce political firestorm that hasn’t subsided even though Bernanke’s steps have been followed by other major central banks, including the European Central Bank.
With this background, economists have pondered what should be done to get ready for the next recession, and the chances that economic conditions may call for rates to go below zero in the future.
With this perspective, more and more economists are arguing in favor of negative interest rates.
What is the obstacle?
Critics argue the idea that negative interest rates would eliminate demand deficiency is ridiculous. They think that rather, it would make people much more aware of the inflow and outflow of their money, which would likely result in less spending. Europe’s experience has eased some of those worries. The Danish central bank found that after rates went negative in 2012, the money market continued to function normally. Rates today in Sweden, Denmark and Switzerland are more negative than they were in Denmark in 2012, yet none has yet seen a surge in currency demand.
In addition, a key reason that central banks can’t set rates as low as they would like is cash. The theory is that savers would take all of their money out of banks rather than be charged a negative rate.
What to do? Well, one idea is to get rid of cash and move to digital payments.
This really would not be that far off from the current reality. Only 7% of transactions in the United States are done in cash, and most of them tend to be small amounts of money. There are only two constituencies left for cash. The elderly and the poor depend on cash and can be helped Criminals also depend on cash because it is anonymous.
For the first time in history, four central banks — the ECB, the Swiss National Bank, the Swedish Riksbank, and the Danish Nationalbank — all currently have negative policy rates.
What about savers?
Savers will no doubt be outraged, but discouraging savings is exactly what significantly negative interest rates are designed to achieve as it would increase investment and eliminate demand deficiency. It is important to highlight that discouraging saving (and encouraging spending) is not a bug of significantly negative interest rates, but a feature.