Opinion: How negative interest rates take money out of your pocket

Negative interest rates, which central banks in several countries have implemented as a way to spur economic growth, is a radical move. In the last of a three-part series, ‘Negative Thinking,’ commentator Satyajit Das examines this policy and its risks.

Low rates are supposed to encourage debt-financed consumption and investment, feeding a virtuous cycle of expansion. They also increase wealth, encouraging spending. Low rates and abundant liquidity should drive inflation.

Instead, these policies since 2008 have brought the global economy a precarious stability at best, and have not created economic growth or inflation.

Moreover, constrained by the zero lower-bound of rates, policy makers increasingly have found it necessary to innovate. They have used quantitative easing (“QE”) to purchase securities to lower interest rates.

They are also using negative rates.

Negative rates work through the same economic channels as low- or zero-interest rates. But negative rates have extra power in that savers facing the threat of actual loss should increase investment and consumption, fueling economic growth and inflation.

The policy also targets the velocity of money, which has declined sharply since the Great Recession and reduced the effectiveness of monetary policy globally. Negative rates are intended to increase the speed of circulation of money, as everyone seeks to avoid the loss caused by holding cash.

It is also designed to encourage banks to lend aggressively. A key objective is to reduce excess reserves held by banks at central banks. The money is the result of QE schemes that have not flowed into the real economy. Negative rates impose a cost on banks, forcing them to increase loans, thereby reducing their excess reserves.

The unstated objective of negative interest rates is currency manipulation. Negative rates are a methamphetamine-boosted form of zero- or low-interest rate policy, designed to devalue a currency as investors move capital elsewhere to avoid a loss.

In truth, negative interest rates are the result of a failure of policies to deal with unsustainable debt levels.

Debt can only be reduced by strong growth, inflation, currency devaluation (where the borrowing is from foreigners), or default. All the strategies other than growth involve some level of transfer of value from savers, either by reduction in the nominal value returned or decreased purchasing power.

In the absence of any politically acceptable and economically manageable solution, policy makers now rely on “extend and pretend” strategies combined with financial repression. Low rates and QE allow borrowings to be maintained to avoid a solvency crisis.

Full article: Opinion: How negative interest rates take money out of your pocket (MarktetWatch)

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