Jan 29th 2020

Negative interest rates will not fix the global economy – just ask Switzerland

by Alla Koblyakova

Alla Koblyakova is Senior Lecturer in Property Finance at the Nottingham Trent University

 

Would you deposit one pound with a bank today if it was going to give you back less than one pound tomorrow? Simple rationality suggests that the answer is no. We are all used to positive interest rates where, say, if the rate is 2% per annum and we put in £100, we’ll receive £102 at the end of the year.

Yet base interest rates have actually been negative in Switzerland, Denmark, Japan and the eurozone for a number of years. This represents a new macroeconomic policy experiment primarily designed to stimulate economic activity: a logical extension of the way that central banks usually cut rates when growth falls away. If negative rates have tended to go unnoticed by many people, it’s only because the rates have generally only been imposed by central banks on the retail banks in their area, and not on most high-street customers.

Negative rates started in 2012 with Denmark, and over the next four years the other jurisdictions joined in – along with Sweden, which became the only one so far to raise rates back up to 0% late last year. With global growth still lacklustre, many believe that other countries may follow suit: US president, Donald Trump, called on the US Federal Reserve to take rates negative, for instance.

Switzerland and Denmark have gone furthest into negative territory, both offering unprecedentedly low rates of -0.75%. The Swiss National Bank, which has kept its rate at this level since 2015, signalled recently that it intends to stick with this experiment and is not ruling out going even more negative. It has said that negative rates were boosting the economy and that the country’s fundamentals were not being significantly affected.

Not everyone agrees on what “not significant” means. Some commentators argue that the policy has been very damaging to the country. So who is right, and what can be learned?

The plan

The base interest rate set by a central bank plays a dual role. It influences people’s decisions on whether to save or invest their money – broadly speaking, people tend to save more when rates are higher and to invest and spend more when it’s cheaper to borrow. At the same time, interest rates influence a country’s exchange rate. The higher the interest rate, the higher the value of the currency.

Central banks in smaller economies such as Switzerland and Denmark introduced negative interest rates both to encourage people to spend more and because bigger players like the US and eurozone were experimenting with another unconventional monetary policy: quantitative easing.

Cuckoo? Emily McCraken, CC BY-SA

This policy was increasing the amount of dollars and euros in circulation, which pushed down the exchange rates on these currencies. This encouraged forex traders to buy the likes of the Swiss franc instead, driving up its price. Since a stronger Swiss franc would potentially hamper the country’s exports, negative interest rates were a way of pinning back the value of the franc.

Incidentally, not all central banks implemented negative interest rates for this reason. The European Central Bank’s decision was for the same reasons as it pursued quantitative easing: to avoid getting sucked into a deflationary spiral, in which people develop a mindset where they think the price of goods is going to keep falling so they decide it is better to hang on to their money than spend it. This would risk grinding economic activity to a halt.

Outcomes

In practice, making rates negative has caused a problem in Switzerland – and much of what follows is true in Denmark as well. The banks know that if they went so far as to charge the average customer for depositing money, customers would simply withdraw en masse. This would wreck the whole banking business model by reducing working capital and causing severe funding problems. So the Swiss deposit rate for ordinary customers is now around a maximum of about 0.25%.

Banks have therefore had to absorb the charges they are paying themselves to deposit their own money with the central bank every day, where in times of positive interest rates they would be earning interest. Banks usually make money on the difference or “spread” between what they pay customers in interest for deposits or savings and what they charge in interest for loans. To minimise the damage to their profits, the retail banks have been unwilling to cut their lending rates to customers beyond a certain level – the average lending interest rate in Switzerland is at just over 2.6%, for instance.

So what the experiment has shown is that once the deposit rate reaches the lowest that banks are willing to go, a central bank can’t further reduce the base rate into negative territory to encourage cheaper lending. In other words, further reductions become ineffective at stimulating the economy.

The retail banks have had to live with reduced profits in this environment – despite performing relatively well under the circumstances. There is also pressure on the country’s pensions industry, since negative interest rates have also helped to turn bond yields negative, which affects how much they can pay to pensioners in benefits.

As a way of mitigating these difficulties, the banks and pension funds have sought riskier investments than usual for their spare capital. In particular, this has driven up the amount of money invested in real estate. Property prices have overheated, taking Switzerland to the brink of a housing crisis. To try and defuse this, Swiss lending rates on fixed ten-year mortgages are now edging upwards – notwithstanding the negative base rate.

In sum, the whole financial system in Switzerland looks more fragile than before. The Swiss National Bank argues negative rates have been successful because they have kept a lid on the Swiss franc, but the country is certainly paying a price.

And until now, public opinion has been somewhat muted because rates have not been passed on to the average bank customer. Yet there are mounting concerns both in Switzerland and in other countries about how people’s pension benefits are being affected, and the prospects of even more cuts to interest rates and perhaps even depositor charges in future.

In the face of widespread popular disapproval, maintaining or even reducing these rates further would be very challenging for central banks. In the hunt for an answer to the global economic crisis, those in charge of monetary policy would be advised to look somewhere else.

 

Alla Koblyakova, Senior Lecturer in Property Finance, Nottingham Trent University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Browse articles by author

More Current Affairs

Jun 19th 2021
EXTRACT: "Xi Jinping’s call for friendship gives us an opportunity to examine Chinese politics on both the domestic and international stage. On the face of it, it suggests the possibility of rapprochement between the rich liberal democracies represented by the G7 and the authoritarian Chinese state. However, despite appearances of a call for a closer relationship, there is more than one way of being friends – and Xi’s idea might be somewhat different to what many in countries attending the G7 might expect."
Jun 12th 2021
EXTRACT: "China’s recently published census, showing that its population has almost stopped growing, brought warnings of severe problems for the country. “Such numbers make grim reading for the party,” reported The Economist. This “could have a disastrous impact on the country,” wrote Huang Wenzheng, a fellow at the Center for China and Globalization in Beijing, in the Financial Times. But a comment posted on China’s Weibo was more insightful. “The declining fertility rate actually reflects the progress in the thinking of Chinese people – women are no longer a fertility tool.” "
Jun 12th 2021
EXTRACT: " I remember recounting fellow leaders of the story of a Rwanda schoolboy caught up in the genocide of the 1990s and now immortalized in the Kigali Genocide Memorial museum, where, in a section devoted to children, one can find his photograph and a plaque that reads: ----- David, age 11 ...... Ambition: to be a doctor ...... Favorite sport: football ...... Favorite hobby: making people laugh ...... Death: by mutilation ...... Last words: the UN are coming to save us ----- In his idealism and innocence, David believed the international community would save him and his mother. We didn’t. "
Jun 8th 2021
EXTRACT: " While many conservative Republicans opposed Trump and saw that he posed a danger to their party and democracy itself, they were hesitant to buck the mass movement they had created, fearing that it would turn against them. Some of these same conservatives assumed that with Trump's defeat, the horror of January 6th, and the former president's banishment from social media, the time had come to restore sanity to their party. But the GOP leadership’s continued cowering in the face of what they now call "Trump's base" has caused them to circle the wagons and purge their ranks of those who call for sanity. "
May 26th 2021
Editor's Note: This article is about the Federal Reserve, inflation in the 1970's, and possible similarities to today.
May 25th 2021
EXTRACT: "Netanyahu claims to be acting in the name of the Jewish people. He certainly is not. Many Jews around the world, including me, despise Netanyahu’s racist politics. As an American, I am also deeply troubled by the US government’s knee-jerk support of Israel. Fortunately, I am not alone in this view. A growing number of Democratic Congressmen, Jews and non-Jews alike, have called on the United States to stop supporting Israel’s lawlessness. The truth is that the US government’s uncritical support for Israel has come to depend more on evangelical Christians, such as former US Secretary of State Michael Pompeo, than on American Jews, who are deeply divided by Netanyahu’s actions. And the evangelicals’ real interest in Zionism is not Jews’ security, but Armageddon, the end of the world, which they believe will come only when all Jews are in Israel."
May 18th 2021
EXTRACT: "This period in US history could go down as the moment when America’s democratic system for electing a president – the most consequential duty of US citizens – was broken, perhaps for good."
May 16th 2021
EXTRACT: "While reading Human Rights Watch’s (HRW) monumental report “A Threshold Crossed,” I felt a range of emotions. It also left me with one big question. I was deeply impressed by the report’s rigorous scholarship. At the same time, it brought to the surface feelings of anger and profound sadness. It’s an extraordinarily complete study detailing not only the many ways Israel has violated a broad range of Palestinian human rights, but the ideology of racial superiority and entitlement that Israel has used to justify its repression." ..... "My advice to both Israel’s defenders and weak-kneed liberals is​, “Read the damn report.” "
May 16th 2021
EXTRACTS: .... "He transformed a transitioning market economy into a stable statist project that rests on an alliance of his inner circle," ..... "He transformed Russia from a respected member of the international community into a rogue state" .... ". He energized NATO by providing it with the adversary it lacked after the end of the cold war," ..... "He befriended hopelessly corrupt, dysfunctional, and unstable dictatorships..." ..... "He forged a quasi-alliance with China, thereby enhancing Russia’s dependence on the one country that might have reason to appropriate those Russian territories inhabited by Chinese."
May 15th 2021
EXTRACT: "On the face of it, the latest escalation of violence is following the template of all inter-ethnic wars. Muslims observing Ramadan shouted nationalist slogans and clashed with Israeli right-wing groups chanting “Death to the Arabs.” The Israelis haughtily marched with their national flag on Jerusalem Day, marking Israel’s capture in 1967 of East Jerusalem and the Temple Mount, the site of the biblical Second Temple, and of Al-Aqsa, completed in the year 705. Battles in and around the Al-Aqsa compound erupted, with worshipers inside throwing stones at the Israeli police, who responded by firing rubber-tipped bullets and other projectiles, wounding hundreds."
May 13th 2021
"Regardless of how the current and future violent conflicts between Israel and the Palestinians in Jerusalem will end, there will be no Israeli-Palestinian peace unless East Jerusalem becomes the capital of a Palestinian state while the city remains united."
May 7th 2021
EXTRACT: " Would the United States be prepared to risk a catastrophic war with the People’s Republic of China to protect the Republic of China, better known as Taiwan? "
May 5th 2021
EXTRACT: "Human history, ancient and contemporary, is replete with instances of genocide – that is, the effort to eradicate a people, erase their history, denigrate their culture, and destroy their physical presence. Many of these atrocities have been recognized by the victims and other nations who support them. But, with the notable exception of the German acknowledgment of the Holocaust, rarely have the perpetrators of these crimes accepted responsibility and offer recompense "
May 2nd 2021
EXTRACT: "The best way to defend liberal democracy is to practice it at home and abroad with the “courage and self-confidence” that Kennan touted at the dawn of the Cold War. This is also the best way to ensure the survival of our own conception of human freedom. And survive it will."
May 1st 2021
EXTRACT: "Ann Arbor (Informed Comment) – Sammy Roth at the LA Times/ Boiling Point Newsletter reports that California’s main power grid was powered for several hours last Saturday by 90% renewables. For just four seconds that day, the grid, which covers 4/5s of the state, reached 94.5% generation by green energy. California is the world’s fifth largest economy. The main grid does not cover Los Angeles County. On the other hand, these figures do not include the electricity generated by the Diablo Canyon nuclear plant, which is not counted as renewable but which is also very low-carbon."
Apr 23rd 2021
EXTRACT: "It is no accident that there has been an economic divergence in Central and Eastern Europe. Those countries that have joined the European Union have improved their economic governance, and GDP has begun to converge with Western Europe. Between 2014 and 2019, Hungary, Poland, and Romania grew at an annual average rate of 3.9%, 4.1%, and 4.7%, respectively. Meanwhile, Belarus and Ukraine experienced minimal growth during this period, and Russia’s economy expanded at an average annual rate of just 0.7%. Though Russia had a higher per capita GDP (in terms of purchasing power parity) than Croatia, Poland, Romania, and Turkey as recently as 2009, all of these countries have since overtaken it. Russians today are shocked to learn that they are worse off than Romanians and Turks. Among EU member states, only Bulgaria is still poorer than Russia. With its close proximity to the EU single market, Russia could have had higher growth if it had pursued sound economic policies. Instead,..... "
Apr 22nd 2021
EXTRACT: "As far as anyone can tell, the US military is not on the verge of an internal breakdown, let alone primed to stage a coup d’état. But few predicted anything like the US Capitol riot before protesters equipped with body armor, stun guns, and zip-ties breached the building. Before the US is blindsided again, its leaders must act resolutely to root out extremism in the military."
Apr 17th 2021
EXTRACT: "The new report on 2020 by the International Renewable Energy Agency reveals that the world’s renewable energy generation capacity increased by an astonishing 10.3% in 2020 despite the global economic slowdown during the coronavirus pandemic." .... "In 2020, the global net increase in renewables was 261 gigawatts (GW). That is the nameplate capacity of some 300 nuclear power plants! There are actually only 440 nuclear power plants in the whole world, with a generation capacity of 390 gigwatts. So let’s just underline this point. The world put in 2/3s as much renewable energy in one year as is produced by all the existing nuclear plants!"
Apr 16th 2021
EXTRACT: "When we examined the development of nations worldwide since 1820, we found that among rich Western countries like the United States, the Netherlands and France, improvements in income, education, safety and health tracked or even outpaced rising gross domestic product for over a century. But in the 1950s, even as economic growth accelerated after World War II, well-being in these countries lagged.
Apr 11th 2021
EXTRACT: "Some presidents indulge in the “Mount Rushmore syndrome” making an obvious effort to achieve greatness. Normally soft-spoken and apparently modest Biden is making his own bid for immortality."