When negative rates become a zero sum game
Stimulus policies should be structured in ways that boost demand
Anyone hoping for a concerted effort to boost global growth will have been disappointed by the familiar combination of bland public conclusions and behind the scenes sniping at the G20 gathering in Shanghai. Policymakers committed to use all tools — monetary, fiscal and structural — to strengthen the recovery. But in reality, many are deferring difficult reforms and hoping that others will shoulder the burden of fiscal expansion. As for monetary policy, there is a clear concern that the latest weapon in central banks’ armoury — the adoption of negative interest rates — may amount to little more than a new way to wage an old-fashioned, beggar-thy-neighbour currency war.
Mark Carney, the Bank of England governor, set out this concern most forcefully. It is critical for central banks to structure stimulus measures in ways that boost domestic demand, he argued, so that a “rising tide” of global demand could “lift all boats”.
Negative interest rates are intended to achieve this, forcing banks to seek out riskier lending opportunities and assets, and encouraging consumers and borrowers to spend. It is plausible and technically possible for them to do so. However, many banks, and policymakers, are proving unwilling to make retail customers feel the full effects.
Mr Carney therefore argues that there are limits to what the latest burst of innovation by central banks can achieve. If they craft policies in ways that shield retail customers, negative rates are unlikely to do much to stimulate domestic demand. Instead, the main effect will be on the exchange rate.
This is attractive to the country concerned but it rapidly becomes a zero sum game, since “for monetary easing to work at a global level it cannot rely on simply moving scarce demand from one country to another”.
This is a clear criticism of negative interest rates as they are practised in countries such as Japan, which adopted the policy in January but has kept paying interest on most bank reserves, allowing banks to keep rates positive for retail depositors. In the clubby world of central banking, such a forthright attack by Mr Carney on his peers is remarkable.
His intervention is also important because the European Central Bank is considering adopting a similar tiered system, which might enable it to cut rates even further below zero without undermining confidence in the eurozone’s fragile banks.
The ECB faces a difficult choice. With the latest data showing that the eurozone has once more slipped into deflation, policymakers are under pressure to cut the deposit rate further into negative territory at this month’s meeting. If they leave lenders exposed to the full effects, they risk triggering a fresh sell off in banking shares. If they follow Japan’s lead and try to shield banks and retail depositors, they lay themselves open to accusations of currency wars.
Yet Mr Carney’s criticism is fair. His concerns are likely to be shared in the US, where policymakers are increasingly calling attention to the risks a stronger dollar poses to growth.
It is also correct to warn that “at the global zero bound, there is no free lunch”. The surge in the value of the yen since the Bank of Japan’s move suggests that using negative rates as a tool for devaluation is at best an unreliable strategy. At worst, it risks reinforcing the impression that central bankers are acting out of desperation.
Mr Carney contends it is a myth that central banks are “out of ammunition”. But he ends his speech with an admission that central bankers cannot restore the global economy to health without help from governments.