The Japanese central bank — Bank of Japan — surprised the world by deciding to have negative interest rates on commercial banks’ excess reserves. What has motivated BOJ to choose this strategy? Three things about Japan using a negative interest rate strategy: (1) To weaken the yen further and help exports, which is a kind of beggar thy neighbor policy that makes countries engage in currency wars of competitive devaluations; (2) to push banks to make more loans and invest more to stimulate aggregate demand, spur lagging growth and increase too-low inflation, and (3) to reduce borrowing costs for companies and households, stimulating demand for loans.
The world’s central banks are engaging in competitive currency devaluations to stimulate their economies through increasing exports. You may add to the negative interest rate strategy the direct currency devaluations by oil exporting countries like Azerbaijan, Russia and Australia to have a good picture of what central banks are doing. This is not always a healthy policy because it can insert systemic risk into the world’s financial markets.
Is BOJ the first to do this? The answer is no. The Swiss National Bank did it a few months ago for the first time since 1970s, and de-pegged its currency from euro to strengthen the Swiss economy. The Bank of Canada also imposed negative interest rates to deal with the repercussions of the collapse of oil prices on its economy. The Riksbank (central bank of Sweden) has also done it. Sweden is a major exporting economy. Denmark also used negative interest rates to protect its currency’s peg to the euro.
There is no clear anecdotal evidence that negative interest rates work. However, the Fed’s Vice Chairman Stanley Fischer said that central banks that had resorted to negative interest rates to stimulate their economies had been more successful in 2012 than he anticipated. It may work when few central banks are doing it, but will it work when many central banks are doing it simultaneously? I see it as a beggar-thy-neighbor policy, which is a similar strategy to one employed in 1929 that brought the world into the Great Depression. But it could now have powerful effects particularly on real estate. On the other hand, negative rates could spread negative rates spread to a range of fixed income securities including government bills, notes and bonds and which will prevent investors from getting their money back on maturity as it happened in Europe in 2015. If banks apply negative rates on deposits, it may make customer avoid having their deposits eaten by banks.
Research is needed in this direction to figure all those things out.
Don’t you wonder why the Federal Reserve System is currently paying commercial banks a +0.25 percent interest rate on their excess reserves at this central bank? Let me add that the Fed is concerned about negative interest rates in the United States. It wants to conduct a stress test on U.S. big banks over the period June 2016 to June 2019 in a hard scenario that simulates a negative interest rate on the three month Treasury bill rates in the United States. This scenario will be embedded with a severe global recession that would send the U.S. unemployment rate up from the current 5 percent to possible 10 percent. It will be a learning lesson for us to see the outcome.
We are living in a strange world with desperate central bankers.