Thursday, June 5, 2014

A Rarity: Negative Interest Rates

A Rarity: Negative Interest Rates

This morning the European Central Bank lowered the interest on overnight deposits by decade pay a small amount of interest for the privilege.[1]  Various other interest rates were also moved downward in an effort to combat deflationary pressures in the Eurozone.  Six years after the credit crisis Europe is still limping along, and the ECB is being forced to contemplate a variety of measures in order to stimulate lending and economic activity.

In theory, negative interest rates should encourage the bank’s to look for more productive uses of their capital.  Moreover, the microscopic borrowing rates should weaken the Euro and help to stimulate exports.  While much of the ECB’s commentary has focused on the creditor side of the ledger, I’ve been thinking about the impact on European savers.

Will European savers begin to withdraw money from banks and put the money under their mattresses? Will European money market funds be able to maintain a one Euro value given microscopic short-term rates plus the administrative costs of running those funds?  Declining inflationary expectations and potentially deflationary pressures are scaring the European Central Bankers.  I’m wondering if this latest move by the ECB will be as ineffective as it was in Japan over a decade ago, because consumers don’t respond to the stimulus.

In my view, Europe is paying for imposing too much fiscal austerity in the wake of the credit crisis.  Moreover, they are victims of adverse demographics.  Europe is rapidly aging.  Without an infusion of younger folks, it’s hard to see where Europe will find sustainable long-term growth.  People in their 20s and 30s spend money and need credit as they establish households.  Given Europe’s tilt toward anti-immigration policies, it seems unlikely that they will address their aging population by importing foreigners.  Of course, there are lessons for the United States as we contemplate immigration reform.

In the short run, speculators may have a field day.  With ever-lower borrowing costs, hedge funds and other investors will be able to put more leverage into their portfolios.  They’d better hope that the ECB’s latest endeavor works.  If it doesn’t, they’ll be buying grossly overvalued securities.  An interesting experiment in monetary policy is underway.


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