I remember sitting in a room years ago loudly proclaiming it would be great if Japan adopted negative interest rates. People snickered.
Well, the Bank of Japan did it last week! I was somewhat pleased. But not everyone was. A few days ago on The Interpreter, Steve Grenville struck a discontented note.
I have sympathy with some of Steve’s points. Of the experience of negative rates so far in the world, he says:
He's right. The small negative rates adopted by central banks so far (and these are rates that apply to the deposits that banks have at the central bank) will not be a powerful force boosting economic activity. But they are better than nothing. They might not get economies exactly where central bankers want them to be, but they will undoubtedly shift those economies closer to the desired destination.
For the individual countries, mildly negative rates may do no great harm, but nor are they the policy breakthrough that will restore the power of monetary policy.
To get all the way to where it wants to be, Japan may need to adopt rates that are deeply negative. But as Steve points out, deep negative rates at the moment are difficult to implement because people (or banks) earning negative returns would prefer to shift into physical cash.
I’ve written about schemes to deal with this constraint before. I even gave a talk about them at Lowy last year. I’d love to see someone try these things. But maybe one day, we won’t need to. Perhaps cash will be obsolete at some point, and interest rates will no longer be bounded below. But I don’t think Steve would be impressed. He goes on to say:
With this challenge (the constraint on interest rates) in mind, many ingenious schemes have been dreamt up to make sure that currency, too, loses its value over time. While these might solve the technical problem, they miss the underlying issue.
Steve suggests the underlying problem is low returns on investment. I agree it would be great if investment returns, and productivity growth, were higher. But I don’t think we know how to get there.
As Andrew Haldane, the Bank of England’s chief economist, noted in a speech last year, real interest rates have been falling for about 25 years. If I were to guess, this is at least partially the result of lower productivity growth, although as noted in a paper last year by some high-profile economists, the relationship between interest rates and growth is weak .
Do we live in a world where productivity growth is lower? Bob Gordon, from Northwestern University, thinks so. He has just written an 800 page book on the topic that’s receiving lots of attention. Basically, Gordon thinks all the good ideas have been had. If that’s the case we live in a world of low growth and low-returns so interest rates will remain … you guessed it, low. And even if we were to get rid of all private sector bottle necks that Steve suggests, that’s not going to help.
One more thing I would like to point out about Steve’s post. He suggests that there is a large degree of `beggar thy neighbour’ growth that results from unconventional monetary policy. That is, if unconventional policies depreciate an exchange rate, then the country loosening policy will gain as their economy becomes more competitive, but those gains will come at the expense of others. The evidence I have seen, however, suggests that the spillovers are, in fact, positive. So while US unconventional policy may lead to a lower US dollar, the stronger US economy provides benefits to the rest of the world that outweigh any loss of competitiveness. Haldane, himself, shows some evidence of that in his speech.
The biggest problem with negative rates is political. People hate the idea, and they are not shy of coming forward with their views. That was made very clear to me in responses triggered by a piece I wrote over a year ago. Unfortunately the comments section is no longer up, but there were some strongly worded statements. One of my favourites was: 'This is an example of why one shouldn't take drugs before publishing articles.'
But while many don't like them, negative rates are not going to go away. They are a natural response to the world we now live in.
Image courtesy of Flickr user rambletamble