February 13, 2016
Neil Irwin had an interesting NYT Upshot piece on the use of negative interest rates by central banks as a way of boosting demand. There are three points worth adding to this discussion.
First, the Fed has other tools to try to boost the economy. The obvious one is to explicitly target a long-term interest rate. For example, the Fed could say that it will push the 5-year Treasury note rate down to 1.0 percent. It would then buy enough 5-year notes to bring the rate down to this level.
Since longer term rates have much more impact on the economy than short-term rates, this would more directly affect the economy than trying to bring down long-term rates with lower short-term rates. If the Fed was really concerned about inadequate demand in the economy, it is difficult to see why it would not consider this sort of targeting. For some reason targeting long-term rates has not featured in discussions of potential Fed actions.
The second point is that low and negative short-term interest rates will give banks an incentive to shed deposits. Since banks will effectively be paying a penalty for the money they hold, they will want less rather than more deposits. This would likely mean that they would up fees for having small checking and saving accounts. The outcome in this case is that many low and moderate income people may give up their bank accounts rather than pay higher fees to keep them.
We already have a large unbanked population. These people often pay large fees at cash-checking services and other non-bank financial outlets to meet basic needs like cashing a paycheck. This is a seriously bad outcome that would result from negative interest rates.
The third issue deals with a brief comment towards the end of Irwin’s piece. He suggests that if people have to pay to keep money, “could people buy physical objects as stores of value that the banks can’t charge a negative interest rate on?”
Actually, this is exactly the sort of response that the Fed would like to see from very low interest rates. If people bought physical assets (presumably ones that didn’t lose value) as a way of avoiding having to pay to hold money, it would drive up the price of steel, furniture, or whatever assets people opted to buy. This would give firms more incentive to produce these assets, leading to increased production and employment. So this story of shifting money from saving accounts to physical assets may sound strange, but is in fact exactly the sort of response the Fed would want from a policy of negative interest rates.
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