Episode 25: Negative Rates -- Another (Delayed) 2008 Hangover

x dot com, futures options and spots. Trading involves risk and may not be appropriate for all industrial Hi am, welcome back to Bloomberg Benchmark, a podcast about the global economy. It is Thursday, February eighteen. I'm Tory Stiwell and economics reporter with Bloomberg News in DC, and I'm joined by my co Hostito, the acting Tokyo Bureauci and Dan Moss are executive editor for International Economics News in New York. Killo, everyone.

So today we are going to talk about a concept that has been an almost inescapable topic in financial news, and that is negative interest rate policies a k A and n r P a k A nerp AK interest rates below zero I prefer nerve out of all of those. I think it has a nice ring to it. We've gone from zup to ner to tarp their nerve, all the acronyms that we love. Basically, it's a policy tool that until a couple of years ago, was extremely UNORTHODOXUS.

Now it's still unorthodox, book becoming less so because some central banks are using it now to stimulate their economies because they're more or less out of other tools to support their economies using more traditional methods. So on January twenty nine, the Bank of Japan joined a couple of these other central banks in deploying a negative interest rate. So it is now part of Tory's favorite NERT club, along with the central banks of the year Zone, Sweden, Denmark,

and Switzerland. And the policy in Japan just went into effect this week, so that makes it the perfect time

of act about it. Yeah, and I also get the sense achy that it was a tipping point in terms of the popular narrative of negative interest rates until the bo J decision, there was a feeling that it was a thing that the Scandinavian countries did and that the e c B did, but that they were real outlies and while you and our team in Tokyo were prepared for a surprise from the Bank of Japan, it sure

wasn't this one. What it's done is it's taken the negative interest rate question away from like, oh, we've got five questions for Janet Yellen, let's add that one too, pretty much the first thing FED officials are asked about. And when Bill Dudley confronted this issue the other day, he seemed a bit frustrated to be const stantly hearing it. And you know, people in Congress have picked up on this idea, and Chay Yellen was peppered with questions about

this last week. I just really get the sense that psychologically Japan changed the game on this. That's right. But before we get too far, we're going to start out with a basic discussion of what negative interest rates even are and how exactly they work. And for that we are welcoming Karen Sho Patrow, who's here in d C with me. Karen is co founder of Federal Financial Analytics. Her firm advises financial services firms on political and regulatory risk,

and negative interest rates certainly could fall into that category. Karen, welcome, Thanks very much. Story so let's start with just a very basic definition and explanation of what negative interest rates are, because it is a pretty topsy turvy concept to think about, just like how we deposit our extra cash in a

bank and the bank pays us interests. Banks themselves have their own bank to park their excess money, which is the central bank or the Federal Reserve for us, and policymakers can move the interest rate they pay up or down right, hockey right, And so we don't confuse everyone. These are a lot of different kinds of interest rates. This isn't the same interest rate as the benchmark interest rate that we talked about in one of our previous

episodes on the set. So if you recall that bank park interest rate is the rate that bangs borrows from each other overnight. This interest rate that we're talking about today, which is sometimes called the deposit rate, sometimes called the interest on excess reserves, is the rate that central banks pay commercial banks to keep cash parked at the central bank. Yes, and a negative interest rate here means that a commercial bank actually pays the central bank a fee to deposit

money there. They're being punished for keeping too much money sitting idle. Instead of lending it out or doing something else useful with it. But you know, totally by making depositors pay money. That's right. So, Karen, why would a central bank want to do something so strange like this? What's the goal? What are the theoretical pros and cons

of this policy? Well, I think, as Aki said, it's a very um crazy, topsy turvy idea to force banks, and if that happens to banks, sooner or later, it happens to all of us as depositors to pay our banks to take our money. And the only reason the central banks in other countries, including Japan, went below what's called zero lower bound was because they really couldn't think of anything else to do in hopes of stimulating economic growth.

One of the most surprising effects of the crisis, combined with all of the really, really difficult economic circumstances we've had, is that central bank monetary policy tools are increasingly blunt. All the things they know how to do didn't work well. And now central banks have thrown trillions of dollars in what's called quantitative easing. They bought trillions of dollars. I read the other day twenty three trillion dollars of assets. Global assets are now housed in central banks, and that's

an amazing number. And even that's not enough. So this is sort of like you know the picturing the DC Metro here, and we have the boxes in the cars where you have like the glass and you pull down a lever in case there's like a giant emergency. That's what nerve is for central banks, so much less cateachorismic, and I call it a hail Mary pass, but in a way having circumstances driven them to a hail Mary pass. One consistent feature of the post two thousand a night

landscape has been the complete absence of inflation. Many people said that all this quantitative easing would produce loads of inflation. In fact, the opposite is happening. So shouldn't the central banks keep swinging even though they cut rights to zero? I think one of the things we need to think through and we don't know the answer to yet. But um, I'm doing a lot of work on this actually right now, because I think the swinging that that could keep swinging.

The other central banks could keep swinging. But finance has changed a huge amount in the wake of the crisis, and every one of the central banks we've talked about traditionally executes monetary policy principally through banks, and banks are very different institutions than they were from the crisis. There are a lot better we hope they're better capitalized, but they don't interact with the economy in the way they

used to US. Banks right now hold well over two trillion dollars of excess reserves at the FED, and it's largely because they don't know where else to put them. So the goal of negative interest rates, then would be to force banks to keep less cash on hand and lend more of it out, you know, to consumers who would spend it, or to companies who want to finance things, build things by equipment, do whatever. Um. So, I guess

the goal is to just stimulate the economy more. That's been paying banks a very low rate of return on the excess reserves if it went negative, and this is exactly why the Bank of Japan went negative. It's basically kicking the kid out the front door and saying get a job. Yeah. And let's also remember, you know, something that thank Japan Governor Corona has been talking about is that this is going to bring down borrowing costs um

for everything. Um, you know the ten year Japanese government bond, you know those went in negative territory of US week that we talked about a little bit um. So this makes borrowing cheaper for everyone, for the companies, for consumers, and the hope is this will for more people to spend money. As contentious as it's been, Corona is not exactly a babe in the woods easy key. Yes. But then I think that's a great question. I think that's

something that we're all asking ourselves right now. This was something that very very few people were expecting um before the Bank of Japan actually announced the policy in January. And you know, kind of the funny thing is when the news first broke on the Bank of Japan, my mom, who's Japanese and she lives in Tokyo, she texted me and she was like, oh my gosh, this sounds like

a terrible thing. I hate it, and sent me these angry and those, and after after the best settled, I was explaining to her that this doesn't necessarily mean that she herself is going to have to pay money to keep money at her own bank. This, you know, is something that applies to commercial banks keeping money at a central bank. UM. But Karen, could you talk about how this policy would theoretically impact consumers with my mom, that's

a great question right now. For the most part, in Europe UM, where negative rates have been in place for the longest amount of time, you've got a really difficult dilemma because the banks are still paying their depositors really tiny amounts of interest to keep funds in the bank. But it's only because rates haven't gone super super low and because they really fear that if depositors had to

actually pay the lost of the negative interest rates. The banks are bearing depositors which just take their money and leave, just keep it under their mattress, keep it under their mattress. Uh, spend it, maybe the way the Fed wants, but perhaps in sudden uncertain ways. There's been speculations some people might put it into bitcoin. Uh, money market funds. I mean, there are a lot of places in markets to put money.

And that's especially true in the United States, where we have a very active non bank equivalent of deposits like money market mutual funds. So the banks are basically in one way, frustrating central bank policy by still paying depositors a little bit. But in another sense, they're desperately trying to cling to their fundamental purpose, which is taking deposits and making loans. Right because if they if they begin to charge this interest rate, people just won't deposit money

with them. Um. And I guess that brings us to naturally to kind of the cons of negative interest rates. What could go wrong here? What has been something or what have been a few things that people have been worried about with negative interest rate? And I think cash hoarding is sort of one of the chief concerns here, both on the part of consumers as well as a commercial banks who obviously have a lot more cash to hoard. Uh, it seems kind of dangerous if they just keep it

all in a vault. So where how does that even work? A really big mattress. I do think what really worries me the most about negative interest rates is how fundamentally it changes the structure of economic growth, of taking deposits and making loans, of financial intermediation. Do you really trend that on its head? You now depositors pay bankers and

bankers pay borrowers, Well, how does that really work? After just a few months maybe it's a short term shock, but you're really fundamentally altering the role of banks, empowering perhaps other forms of financial intermediation again, like mutual funds buying lots of bonds. I don't know, nobody knows. That's

a great point. Well, now that we have a semi form handle on what negative interest rates are, we can head into the second part of the show, which is all about the countries that are actually using them and the results that they've gotten. After a word from our sponsor, what do traders want to limit risk, access every opportunity and trade on a level playing field. Nate x binary options let you set your maximum profit and loss before

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and swaps. Trading involves risk and may not be appropriate for all investors. So we should probably have at least some discussion about what the outcomes have been on those countries that have adopted negative interest rates. Now it's a relatively recent phenomena given Karen, as you said, it essentially upends the economic model. But are there any preliminary lessons we can learn? And I guess we're really talking about

Scandinavia in the Eurozone here. I think the preliminary lessons are mostly, in my mind, drawn from the Eurozone because Scandinavia, for example, Sweden and are very unusual. In Sweden, for example, almost nobody uses physical cash, so the impact of negative rates on deposits is very different than it would be

in the United States or Japan or the Eurozone. And the biggest takeaway I see so far, and why I think negative rates are such a tremendous threat to financial stability if they stay long enough and go deep enough, is that it's having a combination of not really promoting economic growth. The Eurozone is still bumping along the bottom, and it's making banks weaker and weaker. They just cannot keep paying for the cost of negative interest rates without

having places to put the money. Well, if it's such a threat, then how did these decisions get made in the first place. These are serious people, many have spent a lifetime in economic policy making. How did this happen? How did we get here? I honestly think it's because central bankers think monetary policy, not financial stability. In most

central banks, those are on two very different tracks. We learned the hard way in the crisis that if they're on different tracks, you can have a head on collision. But it's not in the gut of central bankers to think about financial stability. They think about price stability, they think about unemployment, and they're not really thinking through how money moves through the economy. What do you do with

the payment system? Is Janet Yellen rightly said last week, Uh, these are questions of Eurozone is just doing, you know, playing um by the seat of its pants here? They don't know. And this is despite the fact that many of these central banks have taken on additional regulatory responsibilities since the crisis. That's very true, Dan, but I think it's new to them and it's not built into their culture.

And every one of these central bankers came of age as a monetary policy expert and a central bank or not as a bank regulator. That's the era when inflation was the number one problem. That's correct. Acky, Are you seeing any of the reverberations from the boj's decision to explore negative interest rates. It's pretty early on and they just rolled it out this week, But are you seeing any impacts there yet? Sure? So? Um I guess the biggest impact so far has been in the financial markets.

Um So, the entire GGB curb the Japanese government, by the old curb that's come down. Uh, Like we talked about earlier, there is now lightly negative yields on even ten year Japanese government bonds, which is completely grandy to borrow money for ten years and not have to pay any interest. Yeah, it's it's not b R. Expecting a drop in some mortgage rates, which should help for the Japanese housing market. There are some signs that it was

flowing bound before the b OJ decisions. You know. The interesting thing here is the foreign exchange market, because right after the Leaguersjapan decision, the end weakened by a lot, But then just a couple of days later, with all this volatility and global markets, its strengthened way past where it was before the b OJ decision, which gives you kind of a sense of how powerless a central bank can be in the space of such large market forces.

And you know, there's this really interesting local opinion poll just a couple of days ago, conducted by one of the local newspapers, and people were asked, will negative interest rates for the Japanese economy? These are Japanese people who are being asked, and I don't know, maybe Japanese consumers are especially pessimistic, but the vast majority of them said no, and only thirteen people said yes that it would be effective. Really Palace, I mean, you've talked at about the negative

impact on Japanese bank stocks, for example. Is that aptance or is it diminishing return? It's a great question. I'm not sure. Like Karen was talking about earlier, banks have already been in this environment of extremely low interest rates for a very long time. So by you know, sending that into negative territory, even just slightly, it's it's it's unclear if that would do a whole lot. But like again,

this is you know, an extraordinary experiment. Um It's it's exciting for us monetary policy journalists, because we haven't seen a whole lot of examples in the past, and doing this quick calculation, and with the b o J joining the links of the prestigious Nerve Club UM, one quarter of the global economy is now run by central banks that have deployed interest rates. So it's really not the fringe thing anymore the way it was in Denmark first

announced a couple of years ago. I think my question is, Karen, do you think more banks are gonna follow? You talked about the you know, extraordinary risks that come with this policy, but it feels like it's becoming more mainstream. In terms of the central banks. I think there are two things that can happen. One is the central bank, like the FED, picks negative interest rates, and the second is that they're imposed on it by market forces and the policy issues.

I think in the United States, either one of those courses has a very different impact, even then in Japan because the dollar is the and Schmark currency and treasury securities are the safe haven asset in the world. And yet is it really such a disaster though, I mean, you can walk down a street in Copenhagen, as I did about nine months ago and not have any sense of impending disaster and a key as you know better than anyone, life goes on in Japan. Yeah, that was

my question too. Have we actually seen anything that catastrophic happen from this very unchartered territory that where in has anything gone wrong yet? At least not in Japan? But you know, the policy went into effect on two days weeks, so there's plenty of opportunity for bad things to happen. I think, Karen, isn't the concern more kind of what happens to the banking system in the long term when you keep bit of interest rates around for such a

long time. That's one of the concerns. It's true, I think I said before and then just bears repeating, we've never done this before war. And how low you go for how long you go in what type of an economy I think is going to determine whether or not it has good effects those desired by the central banks, moderate effects, or really really dangerous ones. And how low are we talking here when when we talk about negative interest rates? What what do those look like in these

various countries. Most of the countries they're relatively modest and minus twenty five or even fifty basis points. Sweeten justment

went much lower chalking the markets. UH. Switzerland has done this, and some of the countries like Switzerland and Denmark are also using negative rates, not so much for macroeconomic purposes, but for exchange rates stabilization, and some of the analysis we've been talking about applies a lot less to them because they're doing it for a very different reason than the Bank of Japan or the e c B. And

how low can we go here? I saw study the other day that suggested that the United States could take rates as low as a minus four point five. But that's good, I couldn't finish it well. I think this is a great opportunity to bring it back to the US. And there is a lot of debate here right now about whether or nerve is something that the FED should entertain, even though it just initiated a tightening cycle here with

interest rates. Stocks have been tanking this year, and there's a ton of speculation about recession risk, and people want to know what the FED can do in case all hell breaks loose in the U s economy. Essentially, and let's be clear that FED still has room to maneuver before it too has to seriously consider negative indust rates. It could, you know, maybe do another round of quantitative easing. It could cut its benchmark interest rate to where it

was before the December hike. But you know, Karen, if if it comes to it, if things get really bad, do you think that FED will seriously consider negative interest rates too? And do you think they can even legally do it, which was a question that came up last week. We know they have seriously considered it because of the paperwork that was released a couple of weeks ago showing an extensive amount of analysis as well as legal thinking

about negative interest rate policy. We know there are folks at the FED or around the FED, such as former Chairman Bernankey, urging the FED to take this seriously. And we know Chairman chair Yellen said last week that it's a tool. Now. I think, Dan, you're absolutely right. Bill Dudley doesn't want to pick it up. And I know everyone I talked about the FED is very, very aware of what a dramatic shock it would be to the

market if the FED were to go nurpe. But just to sort of take a step back, Karen and help us with an overall global document here. Many of the central banks we've discussed either are inflation targeters or have a version of inflation targeting, and typically that target is give or take around two Now they're not close to that, They're not remotely close to it. In some instances, it's going the other way. I should they just do nothing? Is that really a credible response to the ear of

disinflation slash deflation? Oh? I think nothing would be awful. But um, they've got a choice of additional tools. Tories mentioned. Some of them might certainly add into accommodate. A policy in the United States would be politically controversial. Negative rates would be too. There are changes that could be made to the regulations, for example, and I know this is politically controversial, but one of the reasons banks are sitting on so many reserves right now is the new liquidity rules.

There are things the FED or the other are banking central banks could do to freeze some of this money up and try to get that financial intermediation flow working. I think the fundamental problem the central banks are throwing everything they've got trying to get inflation up and growth moving, and the financial system is just not responding. And we need to understand why that is, and I think fixed

for that. I mean, is there anything particular and special to the US financial system that makes negative rates especially dangerous or conversely particularly effective compared to elsewhere? Alright, think, in the United States we have probably the biggest choice of alternatives to negative rates in terms of deposits fleeing

the banking system. And you really could see a very ironic condition in which liquidity rules that are forcing banks to keep lots of and excess reserves create a liquidity crisis as core deposits go flying out the door in hopes of a positive returns. On that cheery note, well this is uh. This has been a great primer on negative interest rates. Karen, thank you so much for joining us, and I guess we'll stay tuned to see what the US ends up having to do over the next few

months and maybe even years. Thank you very much for inviting me to join you, and thanks so as you for listening to Bloomberg Benchmark. Will be back again next week. Until then, you can find us on the Bloomberg terminal and on Bloomberg dot com, as well as on iTunes, Pocket cat Picture, and Google Play. While you're there, Please take a minute to rate and review the show so more people can find us and let us know what

you thought. Our guest Karen is on Twitter at Karen Petrew and you can reach the rest of us at Daniel Moss d C, at Akso seven and at tour. We still will see you next wing. This episode was brought to you by nate X. You know any long term investment is going to go through short term dips and price fluctuations. Nate X binary options that you turn those short term movements into trading opportunities. You decide your maximum profit and loss before each trade, so your risk

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