Central bankers are quietly preparing a policy to fight the coming recession and financial reserves will be used as fuel. Do you know what are they cooking?
Fairly recently, a working paper under the International Monetary Fund (IMF) named “Enabling Deep Negative Interest Rates to Fight Recessions – A Guide” has been brought to my attention via Twitter feed. Its authors – R. Agarwal and M. S. Kimball – wrote it beneath the patronage of IMF and with some degree of consultation and cooperation with central banks of a large number of developed countries, as well as with some of the most famous university institutions.
On 89 pages, the document describes the ins and outs of deep negative interest rates – a tool believed to be a next-gen monetary policy weapon against recession – and the problems and nuances of its application.
To me Deep negative interest rate sounds precisely as the sort of a tool that works flawlessly on paper and leads to many problems out there, in the messy real world. I see it as a tool made out of desperation, rather than prudence. But that is my subjective take; what do the authors think about it? And what surprises do the central banks hide in their sleeves?
A negative interest rate is a measure, which turns the well-known world of finance upside down. With a negative interest applied the creditor pays the debtor for having lent him some money. Bank’s clients pay the bank an interest for having their money stored at the bank. When taking a mortgage the bank deducts the used interest rate from the monthly payments of the client. What kind of sorcery is that? Technically, you get paid for taking a mortgage? The bank willingly slices her revenue? What?
It seems unlikely that market participants – especially in the case of lending and borrowing money – would voluntarily and of their own accord dive into negative interest rate territory, simply because the money flow is reversed and doesn’t make sense. Why would you pay someone to borrow money from you? I reckon however that we shall soon see new publications and articles convincing us of the reverse – that the negative interest rates are in fact natural, obvious and ever-present (I suspect the main motive of these articles will be to mould and shape public opinion to be more accepting). One such article called, eloquently, The Non-Weirdness of Negative Interest Rates, argues precisely that. The author, J. Weisenthal, says that if you buy some oil or grain in order to speculate on its price, you will have to store it somewhere and you will pay for the storage services. And the storage fee will technically be a negative interest on your investment. Similarly, if I deposit a golden nugget into a bank’s security storage box, I pay her for having my nugget secured, which again according to Weisenthal represents a negative interest incurred. Hence, he would say, negative interests are all around us so it only makes sense they start appearing in finance as well.
However, he’s missing one thing: if I pay someone to store my oil, grain or golden nuggets, it will remain there. On the other hand if I deposit money into a bank account, the money doesn’t stay there, for the bank runs leveraged operations and the depositors’ money is being used in various operations to create a profit for the bank. Therefore if I shall pay a negative interest on my bank account balance, I am in effect paying a bank for her having my money at her disposal to be used in her own operations to make profit… for her. And why would I pay for that? It is not the same and it is not natural. It’s weird. (Here I dare make a short detour – I assume that in the very early days of banking one would deposit cash to the bank, the cash would stay there, and one would pay for the storage service. Difference between this and what the banking became is their ability to pool money in and lend it / invest it elsewhere. Hence the risk of bank runs).
However, the zero lower bound is not a law of nature; it is a policy choice.
– sentences in italics are direct quotes from the working paper –
Deep negative interest rate means that the interest rate applied would be deeply below the lower bound. How deep? I have no idea and the paper doesn’t say. Could it be – 5 %? Maybe – 10 %? Would there be any limit to it or would the end goal of fighting recession dictate the means? We are left guessing…
(Mild) negative interest rates are a new tool available on the markets. They have been used for the first time in 2009 by Swedish central bank (CB), in 2012 by Danish CB, in 2014 by European CB and two years later, for specific cases, by Bank of Japan. Negative interest rates are then a young tool that hasn’t been tested by the most reliable test of all – by the test of time. Deep negative interest rates are totally without precedent and their impact is only an estimate based on theories and modelling.
Why would the deep negative interest rates be used at all?
The classic tool of monetary policy used in times of recessions is the lowering of interest rates. Low interest rates make money “cheaper” to obtain and thus allow for more liquidity to be channelled into the economy. However, after the 2007-8 crises the interest rates have remained rather low and the central bankers are worried they do not have enough space to lower them further. “Luckily,” somebody had an idea: what if zero ceased to be the lower bound? What if we could go below zero? Of course if you go below zero then the space to manoeuvre becomes huge and only the, well, bankers’ imagination is the limit.
The theoretical power of widely applied deep negative interest rates resides in exposing the private sector and households to the pressure of continual loss accrued by their savings, i.e. the money they “sit on.” The idea is that by forcing the businesses and households to either invest or consume their savings, the economy will get stimulated by the inflow of new capital and will climb out of recession. It is, in a way, very, very simple.
How do they propose to apply the deep negative interest rates?
Presently, we have two primary kinds of money circulating in the economy: the electronic money and the paper currency (along with coins – cash). Electronic money lies at the mercy of banks and may be subjected to negative rates very quickly. In my imagination (and with only a slight exaggeration) all that is need is a few clicks and some paperwork to back it up. The solution here is obvious: transform the electronic money into cash. Unfortunately, banks have that option covered by what they call the Negative Paper Currency Interest Rate (NPCIR). How would they go about implementing negative interest rate on cash?
First option is to break the parity of electronic and paper money, to make it unequal. A given item, let’s say a can of tuna, would then cost 100 czk when paid by card and 103 czk when paid by cash. This would represent a negative 3 % interest rate and it would motivate cash holders to exchange cash for electronic currency.
Second option is to impose limits on increasing the cash in circulation by putting hard limits on ATM or bank window withdrawals along with fat fees. An example given in the paper is that of a withdrawal limit per transaction being $200 and the fee paid $3. On $600 withdrawal that’s $9 in fees.
Focusing first on household depositors, here are some of the ways commercial banks might discourage large cash withdrawals:
- Put fees on each withdrawal transaction at a bank’s own ATMs and impose a maximum amount for each cash withdrawal.
- Impose similar fees at the human teller windows.
- Alternatively, discontinue cash withdrawals at the teller window, directing customers to the ATMs.
- Keep a low inventory of cash in the branch (other than in the ATMs themselves), so tellers could often tell customers honestly: “I can’t; I don’t have enough cash here at my window.”
All of these fees, restrictions, and obstacles will seem more acceptable to customers [emphasis mine] if there is a certain amount of paper currency withdrawal each month that is exempt from these fees, restrictions, and obstacles.
All of these dubiously sounding steps serve, along with a maximum cap imposed on a daily cash transaction between two subjects (in Czech republic the cap is 10.500 EUR give or take), one clear purpose: to push cash to the periphery of financial transactions. The more money is stored in an electronic form, the easier and faster it gets for the banks to control it and manipulate it with interest rates.
However, the truth is that we are taking these steps ourselves by taking the convenient route – payments by cards and better yet, by phones and smart watches, using ApplePay and GooglePay, we slowly move to a cashless society. The banks rejoice, I presume.
Some “small” objections…
I have written that the whole operation will rely on consumption and investments done by households and the private sector. However, this is not entirely accurate. IMF believes that such a deal may not be quite popular among the citizens and it could raise up some objections, not to mention direct opposition. Therefore they propose that smaller individual accounts shall be freed from negative interest rate and given a 0 % interest rate, so as to avoid skimming the small guy. BUT – in the same working paper they propose the threshold for negative-or-zero interest rate to be 2.500 EUR. In Czech Republic this represents about 2 (!) gross average monthly salaries. This also means that should the proposed threshold be accepted, the negative rates would affect many people. The banks shan’t have a “skin in the game” – it will be other peoples’ money that will be put on the bet.
My second objection is towards the character of the proposed changes in monetary policy and towards the feeling I get from the whole document. The authors appeal to the financiers for a quick and quite implementation of the proposed changes with the aim to avoid attracting public and media attention as much as possible. Every single appeal of this sort raises an appropriate amount of suspicion. One of the key aspects of this silent sneaky approach is to use commercial banks for the application of negative rates on retail customers. The commercial banks would be exposed to negative interest rates at the central bank’s cash window and they would transfer it through their services to the retail. In practice, the negative interest rate would then appear as a new item on the fees & charges list of the bank. And herein lies the trick: a customer would complain to the commercial bank, but not to the real villain pulling the strings in the background.
Relying on banks for transmission of a negative rate of return on paper currency reduces the implementation burden and political cost associated with negative rates. When working through banks, anything that would be a political problem for the central bank becomes a customer relationship management problem for the commercial banks. Commercial banks are likely to be better and more experienced in dealing with customer relations problems—even those with a new twist—than central banks are at dealing with grassroots political problems. After minimalist implementation (at the central bank cash window), the central bank can leave the rest up to the private sector. One key aspect of bank transmission approaches is that the less the central bank does and the more is done by commercial banks, the less new legislation is likely to be needed. [emphasis mine]
And last but not least, the pressure to move to a cashless society is also a pressure to dismantle one of the last havens of personal privacy – the right to buy and spend anonymously, without the purchases being tied to my name, the place, the time, the amount spent and, of course, the contents purchased.
The banks would have you believe that anyone using cash is trying to participate in illegal activities, but wait until they try to connect health insurance companies to the contents of your groceries & adjust the insurance rate according to whether your groceries is healthy or not (based, of course, on the shaky institutional definition of “healthy”).
Some GRAND objections…
Firstly – throughout the entire document the authors are preoccupied with protecting the central bank’s and the commercial banks’ bottom line, i.e. on how not to hurt their profits by implementing the negative rates. But nowhere do they stop and comment that the whole burden and the lot of the losses will be borne by households and the private sector. Mind you, this includes retirees and people nearing the retirement age.
I am aware of the economists and professors who always like to argue that having money simply “sit” in your bank account is “not efficient” and that you should “keep them moving.” To this I reply: I am certain that many of the people who have invested their savings in 2005-7 had wished they had kept them sitting in their non-Lehman-Brothers bank account.
I am also aware that the S&P 500 has nearly doubled from the 2007 high and nearly tripled from the 2009 low, but hold your savings through a 50 % drawdown and then come tell me. Otherwise drop the talk about “strong hands” who also happened to hold the winning cards.
Secondly – the authors emphasize that the deep negative interest rates would be “a temporary” quick-fix solution to solve the recession and in the text they mention some 18 months. How many could it be in reality? I’d say that when they lowered interest rates back in 2008-9 it was also meant to be “temporary” – and we still have them low. Now it’s a problem and now they have prepared a new “temporary” solution. Nassim Taleb has a beautiful aphorism in The Bed of Procrustes which goes something to the likes of: “nothing is as permanent as the solutions called temporary.”
Thirdly – hidden risk. In Denmark these days one can get a mortgage with a negative interest rate. This doesn’t mean that the bank would send you a check every month – it simply means that the monthly payment will be reduced, not increased, by the interest rate. The bank still makes some profit on the mortgage, mainly through administrative fees (The Guardian, 2019).
A new situation is thus emerging: financial loans with negative interest rate shall become more attractive and I speculate they will be taken on by people, who are not solvent enough to take them. This is a build-up for 2005-6 all over again and we know how that evolved. This worries me: if banks make profit on mortgages not through interest rate but through administrative fees, then they shall need to hand out a *huge* amount of mortgages to make a solid profit. You see where this goes.
Individuals, households and the private sector would actually be pushed towards increased spending and investment by the negative rates. The authors emphasize that the car loans, mortgages, venture-capital and start-up funding… will be all made more affordable. The also mention those companies that “sit” on heaps of hoarded cash and enjoy current positive rates and “easy” returns. They say these companies will see their profits evaporate and their losses from “holding” amounting, which will prompt the company management to invest in new projects.
All of this sounds very nice, BUT (there is always a but), somebody has to pay all this and remember, the authors of the paper were very preoccupied with protecting the banks’ profits, so it’s not the banks who is going to cover the bill.
Reading between the lines I see a single thread uniting all the single steps, propositions and processes towards one great goal: to push the households and the private sector to increase their investments and consumption. And I can imagine it will work beautifully for some time, yet I dread the day when… the repayment of the cheap mortgages and loans stalls; when start-ups with lots of cheap VC backing start crashing; when those companies that to avoid losses were forced to invest their hoarded cash even into secondary quality project see those investments break… It seems to me that a falling consumption is to be resolved by an immense pressure to increase consumption; the desire for greater speed will draw us closer to the center of the storm where the winds are fastest but, alas, sails wear and tear under the tremendous strain.
Risk hidden beneath the rug
My concerns regarding the deep negative interest rates stem from how uncertain and unpredictable this tool is. It hasn’t been tried before and its effect in the supremely complex world of global economics is in my opinion unpredictable and un-doable. Once it’s let out of the box, it will forever change the nature of the markets. Forever the market participants will be aware that it could be used again. The characteristics of this tool also mean that we cannot properly measure and understand all of its risks. Some might say: “extreme times call for extreme measures and we shan’t be afraid to use new, powerful tools.” I say to that no, let us not be afraid to use new tools, but before we do so we shall be able to protect ourselves from the worst-case effects of such tools. Then, if they fail and cause harm, the harm shall not be fatal. In the language of risk management we shall “clip the left tail”, in other words do our utmost to prevent ruin, and then and only then can we start thinking of using these tools. Let us not cut off the branch we are standing on simply because somebody says we need to keep the fire going.
I reckon there are many dark scenarios that could come into play. I’m going to mention one that haunts me: if people see negative interest rates carving deep into their savings, and if the “temporary” solution starts to take long, I’d be worried that people might lose faith in a given currency. When the faith corrodes and people flee to other currencies and assets… then hyperinflation begins lurking around the corner. And we know where these lead…
Few words to conclude
The goal of the deep negative interest rates, the authors conclude at the end of the working paper, is to quickly recover the economy, while after this recovery the interest rates could return to “normal.”* This makes me wonder – shall we want a *quick* recovery or *good* recovery? For recoveries have legacies, just like when one quickly and sloppily rebuilds a house, it may collapse upon the first tremors, leaving one worse off. The bankers’ actions in the aftermath of the 07-8 crisis still carry their effects to this day. Nay, they may be the reason why people are still searching for a wait out, ready to exchange one tool for another. I pray they may be right, but I shall try to be prepared if they are not.
* Although… what really is the “normal”?
Agarwal; M. S. Kimball – IMF Working Paper – Enabling Deep Negative Rates to Fight Recessions: A Guide. April, 2019, available at:
Collinson pro The Guardian, 2019, citation on 20. 8. 2019, available at:
Weisenthal for Bloomberg, 2019, citation on 20. 8. 2019, available at: