by FERDINANDO GIUGLIANO/ pic by BLOOMBERG
THE titans of finance have a new foe, and it’s not Jeremy Corbyn or Elizabeth Warren. Wall Street’s elite is attacking Europe’s central banks over their reliance on negative interest rates, saying they’re hurting the economy.
Monetary authorities do need to be mindful of the side effects of unconventional measures. But there’s little evidence that negative rates are proven harmful. They might be more effective if bankers passed them onto consumers more.
Europe’s central banks have used negative rates since the start of the decade. They charge lenders for the money they park in a central bank’s deposit facility above a certain threshold, in the hope that this will force commercial banks to lend more. In September, the European Central Bank cut its deposit rate further to -0.5% (while introducing some exemptions for banks through a system called “tiering”).
Bankers are scathing about the overall policy. Last month, James Gorman and Jamie Dimon (picture), the CEOs of Morgan Stanley and JPMorgan Chase & Co, delivered a double whammy: “What Europe is experiencing with negative rates is obviously very bad,” Gorman said, “not just for banks, but for the economy. God, I hope it never comes here (to the US)”, said Dimon. Goldman Sachs Group Inc David Solomon said negative rates are a “failed experiment”.
A negative deposit rate forces banks to take a hit on profits, especially when they decided not to pass these charges onto consumers. This pressures lenders that are already squeezed by the tight spreads between their deposit and their lending rates.
There are three arguments against negative rates. The first is that they encourage irresponsible lending, fuelling bubbles and creating the conditions for a financial crash. Second is they’ll prompt savers to take too much money out of the banking system, to avoid paying for the privilege of depositing cash. Third is there’s a “reversal rate” below which a central bank prompts lenders to cut back on their lending instead of increasing it.
This boundary creeps up over time, curtailing how long the monetary authorities can keep interest rates low. Fears about financial stability are the most compelling case against negative rates. They’re also the least specific.
Other policies — including low rates, asset purchases and generous loans to banks — are vulnerable to the same accusations.
Central bankers have to use these unorthodox measures to try to bring inflation back on target and to stimulate growth, which is their mandate.
There will always be a trade off between stimulating an economy and encouraging excessive risk-taking, which supervisors address through other policy levers such as higher capital requirements.
Raising rates at this stage would simply lead to a sharp slowdown in the economy, causing a wave of defaults. Hardly a recipe for financial stability.
Meanwhile, the risk of people stashing their money under the mattress is difficult to imagine with modestly negative rates. Few banks have passed negative rates on to their customers, generally doing this only to large corporate clients and wealthy savers.
It’s possible theoretically that extending this to smaller depositors could prompt a bank run. Yet, there are costs to storing and insuring cash. Moreover, we know businesses and consumers are prepared to pay for holding cash in more convenient ways.
Finally, there’s little evidence that negative rates have held back lending. At the same time, companies with large cash holdings have cut their deposits and invested more.
That’s exactly the goal of this policy. In fact, banks that pass on negative rates to customers appear to provide more credit than other lenders. This suggests that, the problem with negative rates is that not enough banks inflict them on their clients.
It’s certainly possible that monetary policy becomes less effective as central banks cut interest rates deeper into negative territory. Similar diminishing returns are seen in other unorthodox measures, including asset purchases.
So far negative rates have been confined largely to Japan and Europe. For all the enthusiasm of President Donald Trump, Jerome Powell doesn’t think the US will be copying the policy.
Wall Street should feel safe then. That doesn’t mean it is right. — Bloomberg
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.