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OPINION

Negative rates? No thanks

Negative rates? No thanks
February 28, 2013
Negative rates? No thanks

I suspect that Mr Tucker’s intention in (re)floating the idea was not so much to signal that negative rates are on the way, as to talk sterling down and to assure that some policy-makers at least are concerned to increased economic activity.

However, I suspect there are good reasons why the Bank has for a long time rejected the idea.

The intention behind it is the same as the idea behind any interest rate cut. If banks earn less on the money they deposit with the Bank of England, they’ll have less incentive to deposit cash safely, and so will want to lend more to households and businesses.

But there’s a problem with this. The rates at which banks lend to businesses are already well above the rate at which they lend to the Bank. So they already have quite a strong incentive to lend. So why aren’t they doing so?

One reason is that the demand just isn’t there. The latest survey of regional economic conditions by the Bank’s own agents found “weak demand for credit.” And the latest survey of manufacturers by the CBI found that only four per cent of firms say output is constrained by an inability to raise finance and only five per cent say capital spending is thus constrained. Most firms aren’t borrowing because they are worried about the future and can’t see good investment opportunities. A marginal cut in interest rates won’t radically change this.

Granted, some very small firms would like to borrow. But banks regard these as risky – whether rightly or wrongly is another matter – and this won’t change much if rates fall a little.

In this context, charging banks to keep their money at the Bank might not stimulate lending much. What it might do instead is cause banks to switch into other safe assets, such as government debt, causing a fall in gilt yields. Granted, this would reduce the government’s borrowing costs – though of course financial repression couldn’t possibly be the motive for such a move – but it would also depress annuity rates and increase pension fund deficits.

Which brings me to another problem. Those lower annuity rates, allied to even lower savings rates on deposits as banks try to recoup money lost on lending to the Bank of England, would clobber savers. How would they react?

With anger, naturally. But the Bank will shrug this off. MPC member Paul Tucker said this week: “We have to set policy for the good of the economy as a whole, in line with our Remit. Ultimately, economic recovery is in everyone’s interests.”

The hope is that lower savings rates will have a substitution effect: with returns on savings pathetic, people will spend instead. But they also have an income effect; people might try to save more to make up for lower future wealth. To the extent that they do so, lower rates would be deflationary. Granted, there’s a positive income effect upon people with tracker mortgages. But if they use their extra free income to pay down debt rather than spend, activity won’t increase.

On top of all this, there’s another problem which Bank officials have been stressing recently. It’s that even if I’m wrong and negative interest rates would boost activity significantly, the impact is only temporary. Mr Fisher – echoing Sir Mervyn – says: “Monetary stimulus works by giving an incentive to businesses and households to spend now rather than in the future. That creates only a temporary boost to growth.”

The zero lower bound on interest rates might not, therefore be a technical bound, as negative nominal rates might be feasible. But it is an effective bound, in the sense that there are limits to what monetary policy can now achieve.