Once upon a time, people actually got paid to lend money.
It was something that early humans called “interest.”
But now central banks are doing what didn’t seem possible before: cutting interest rates into negative territory.
So why are central banks doing this now, and why would anyone ever buy a bond that pays a negative rate? Well, they’re cutting rates for the same reason they always do: because growth and inflation are both too low. Negative rates should help that by not only lowering borrowing costs for households and businesses, but also by boosting exporters with a weaker currency. After all, who wants to pay a European bank to hold your money in euros when an American bank would pay you to hold it in dollars? Nobody who can help it. And selling your euros to buy dollars is just another way of saying that there’s less demand for euros, so its price falls.
That brings us to the bigger question, though: why on earth would anyone pay their bank to deposit money in it? That’s what was supposed to make negative interest rates inconceivable. People would just start holding their money in cash that didn’t cost them anything instead of a bank account that did—right? Well, it turns out cash does not mean what you think it means. At least not for negative interest rates that are only slightly so. As Paul Krugman points out, keeping your money in cash isn’t free assuming you don’t just stuff it in your mattress. Safes cost money, and as long as negative interest rates cost less, people will keep their money in banks. Nobody knows where that is, but somewhere around a negative 2 percent rate seems right.
The only problem with negative interest rates is that our financial system wasn’t built with them in mind as even a possibility. Banks, you see, don’t like to pass the full cost of negative rates on to their depositors for fear of losing them, but do feel like they have to pass the full benefits of negative rates on to their borrowers for fear of losing them to a competitor. That means that their interest income—the difference between what they pay to and charge people to borrow—is squeezed even more than it already was when rates venture into negative territory.
If negative rates hurt bank earnings so much that they cut back on lending—which, to be clear, hasn’t been the case so far—then it’s possible that they wouldn’t help the economy all that much. And that would mean we’re in a lot more trouble than we thought. Think about it like this. Central banks around the world are already printing quite a bit of money, but that hasn’t been enough to stop global markets from flashing a bright red recession warning. So if it turns out that negative rates don’t do much to revive growth, then there’s not a lot more central banks can do—or so the story goes. I don’t think that’s true since central banks can always print more money or promise not to raise rates for a long, long time, but markets are worried it is.
Posted from Diigo. The rest of my favorite links are here.