CENTRAL BANKERS MUST BEWARE THE POLITICAL "LOWER BOUND" / THE FINANCIAL TIMES OP EDITORIAL

Central bankers must beware the political ‘lower bound’

Monetary policy risks losing public support in perceived clash with national values

Karsten Junius


Policy rates of less than zero seem to work more smoothly than many had feared. Even in countries such as Switzerland — where the benchmark deposit rate is minus 0.75 per cent — rates remain more than the much-discussed “lower bound”, below which their economic disadvantages start to outweigh their advantages. However, central banks have underestimated the political lower bound, under which public support erodes.

At this point, pension funds and households might not withdraw cash from their commercial banks but rather their political support for their central bank. Over the long term, this will threaten central bankers’ standing in the political arena. If governors want to use negative rates for longer or lower them even further, they must better explain their rationale.

For about five years, several central banks have been setting policy rates at less than zero. This practice provoked a few big concerns among investors. First, money markets might not work properly below zero. Second, investors and households might withdraw their deposits and store them in their vaults or under the mattress.

Third, economic disadvantages could outweigh their advantages if rates fall below the so-called reversal rate or lower economic bound.Money markets are still working smoothly. Deposits in the banking system have also remained stable, indicating that the economic lower bound has not yet been reached. This supports the argument made by the Swiss National Bank and the European Central Bank that deposit rates could be lowered even further.

The negative side-effects feared by critics included accelerating inflation, financial market instability, and even a zombification of the corporate sector. Some also criticise the distributional consequences, as debtors benefit and creditors lose out. However, it seems that negative rates have served their purpose.

In the euro area this was to strengthen domestic demand and inflation expectations by complementing other monetary policy measures such as forward guidance, asset purchases and targeted long-term refinancing operations. Credit growth to households and companies has recovered since the crisis, non-performing loans have fallen and banks’ balance sheets have benefited from higher asset prices. Even better, unemployment rates have fallen significantly.

Despite this record, negative rates continue to be heavily criticised in public. In mid-November, a poll in Germany found that 58 per cent of those surveyed preferred higher interest rates even if that meant higher borrowing costs, while 32 per cent preferred lower interest rates. German policymakers are even debating whether to outlaw negative interest rates for private savings.

And newspapers nationwide report if a bank anywhere in the country dares to pass on negative policy rates to its clients. Many newspapers and policymakers blame the ECB for expropriating the savings of ordinary people. The Swiss Banking Association goes even further and claims that “negative interest rates are difficult to reconcile with Swiss values”, and that it is “immoral” to reward people for amassing debt.

The frequent use of the term “penalty rate” underlines this normative interpretation of policy rates. This is a problem and a communication failure of central banks. No empirical study on the advantages of negative rates will convince anyone who has a traditional approach. If you believe that amassing debt is bad or even immoral, and that saving is a virtue, you are hardly incentivised to alter your behaviour if interest rates change.

As a result, monetary policy becomes ineffective or at least inefficient. It focuses on stimulating borrowing, while stronger private consumption would have an even greater effect on aggregate demand and make investment spending naturally more profitable.



Central banks just need to be honest and state clearly that it is in their interest that commercial banks pass on policy rates to their customers — even if they are negative — as the intention of negative rates is that households save less and consume more.

Finally, it is of utmost importance to explain the need for unconventional monetary policies to private households, as the latter make up 100 per cent of voters. If the constituents do believe that central banks pursue policies that are not beneficial for them, and if they feel unfairly penalised, they are more likely to demand more democratic control over monetary policy.

Central banks should be aware that this threatens their independence. They should try to better explain the advantages of their policies to the general public, and thereby make them more acceptable and efficient. This approach might have a better chance of stimulating the economy than lowering rates further or keeping them negative for longer.

At current interest rate levels, the political lower bound appears to have been reached in Europe. It would take either a strong recession or a very successful communication strategy for central banks to lower rates again. So far, both look unlikely in 2020.


The writer is chief economist at private bank J Safra Sarasin