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Wall Street Is Wrong About Negative Interest Rates

Ferdinando Giugliano

(Bloomberg Opinion) -- The titans of finance have a new foe, and it’s not Jeremy Corbyn or Elizabeth Warren. Wall Street’s elite is attacking Europe’s central banks over their reliance on negative interest rates, saying they’re hurting the economy.

Monetary authorities do need to be mindful of the side effects of unconventional measures. But there’s little evidence that negative rates are proving harmful. Indeed, they might be more effective still if bankers passed them onto consumers more.

Europe’s central banks have used negative rates since the start of the decade. They charge lenders for the money they park in a central bank’s deposit facility above a certain threshold, in the hope that this will force commercial banks to lend more. In September, the European Central Bank cut its deposit rate further to -0.5% (while introducing some exemptions for banks through a system called “tiering”).

Bankers are scathing about the overall policy. Last month James Gorman and Jamie Dimon, the chief executive officers of Morgan Stanley and JPMorgan Chase & Co., delivered a double-whammy: “What Europe is experiencing with negative rates is obviously very bad,” Gorman said, “not just for banks but for the economy.” “God, I hope it never comes here [to the U.S.],” said Dimon. David Solomon, the boss of Goldman Sachs Group Inc., says negative rates are a “failed experiment.”

Such protests are obviously self-serving, though they’re understandable too. A negative deposit rate forces banks to take a hit on profits, especially when they decide not to pass these charges onto consumers. This pressures lenders that are already squeezed by the tight spreads between their deposit and their lending rates. However, Dimon and Co. are on shakier ground when they claim to be speaking for the common good.

There are three arguments against negative rates. The first is that they encourage irresponsible lending, fueling bubbles and creating the conditions for a financial crash. The second is that they’ll prompt savers to take too much money out of the banking system, to avoid paying for the privilege of depositing cash. The third, associated with the work of Markus Brunnermeier and Yann Koby at Princeton University, is that there’s a “reversal rate” below which a central bank prompts lenders to cut back on their lending instead of increasing it. This boundary creeps up over time, curtailing how long the monetary authorities can keep interest rates low.

Fears about financial stability are the most compelling case against negative rates. They’re also the least specific. Other policies — including low rates, asset purchases and generous loans to banks — are vulnerable to the same accusations. Central bankers are having to use these unorthodox measures to try to bring inflation back on target and to stimulate growth, which is their mandate.

There will always be a trade off between stimulating an economy and encouraging excessive risk-taking, which supervisors address through other policy levers such as higher capital requirements. Raising rates at this stage would simply lead to a sharp slowdown in the economy, causing a wave of defaults. Hardly a recipe for financial stability.

Meanwhile, the risk of people stashing their money under the mattress is difficult to imagine with modestly negative rates. Few banks have passed negative rates on to their customers, generally doing this only to large corporate clients and wealthy savers. It’s possible theoretically that extending this to smaller depositors could prompt a bank run. Yet there are costs to storing and insuring cash.

Moreover, we know businesses and consumers are prepared to pay for holding cash in more convenient ways. For example, merchants and users pay fees for using credit cards.

Finally, there’s little evidence that negative rates have held back lending. A recent ECB working paper shows deposits with commercial lenders have increased since the central bank introduced negative deposit rates. At the same time, companies with large cash holdings have cut their deposits and invested more. That’s exactly the goal of this policy.

In fact, banks that pass on negative rates to customers appear to provide more credit than other lenders. This suggests that, contrary to what those Wall Street titans say, the problem with negative rates is that not enough banks inflict them on their clients.

It’s certainly possible that monetary policy becomes less effective as central banks cut interest rates deeper into negative territory. Gauti Eggertsson of Brown University and Larry Summers of Harvard have looked at Sweden, a pioneer in cutting rates below zero. They concluded that while its first two negative moves reduced lending rates, this wasn’t repeated after two later cuts.

However, similar diminishing returns are seen in other unorthodox measures, including asset purchases. The authors also acknowledge that the rate cuts might have boosted Sweden’s economy via other channels, for example by depreciating the krona, allowing the government to borrow more and boosting asset prices.

So far negative rates have been confined largely to Japan and Europe. For all the enthusiasm of President Donald Trump, Jerome Powell, chairman of the Federal Reserve, doesn’t think the U.S. will be copying the policy. Wall Street should feel safe then. That doesn’t mean it is right.

To contact the author of this story: Ferdinando Giugliano at fgiugliano@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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