Interest Rate Insanity


In theory, when you are dealing with a depression or trying to avert one, there could be advantages to negative interest rates. In practice, though there may be some short-term benefits, in the medium to long term they are an act of insanity.

The European Central Bank has been flirting with this ludicrous policy for a while: in June 2014, the ECB cut its deposit rate (the interest rate that it pays on reserves held by the central bank) to minus 0.10%. In September, they cut this rate again to minus 0.20%.

Yes, that's right - they charge you for lending to them.

Because this triggered a flight of money from the Eurozone to Switzerland which the Swiss central banks found excessive, they decided to try to choke this off by also adopting negative interest rates in December at minus 0.25% on deposits.

The theory behind this barmy policy is supposed to be that charging banks for holding money with the central bank would force them to seek better returns elsewhere, either through investing in productive assets in the monetary union or transferring their money to safe assets overseas.

In the first case, the additional productive investment would supposedly help drive up growth directly whereas in the second the capital outflows would help drive the currency's exchange rate down and make exports more competitive — thereby improving growth prospects.

The main problem with this, in my opinion, is that expected returns for those who save and invest are harmed by low interest rates, and when you pass the psychological barrier of actually allowing interest rates to be negative you risk doing serious damage to long-term attitudes towards savings and investment.

However, there are also short-term issues and it would appear that the policy is not working out well either for the Eurozone or Switzerland even in the short term.

The part of the policy which has gone to plan is that it has succeeded in pushing the Euro down against other currencies, and the Germans have managed to export more in consequence.

But over the Eurozone as a whole the expected growth has simply not materialised - indeed, growth prospects appear to be getting worse.

Negative interest rates are not working for the countries in the Euro and I doubt they will work for the Swiss either. Indeed as a banking centre the Swiss have more to lose

There is a very good article on this on the Business Insider site here

Lets hope the Bank of England continues to resists any temptation to adopt the disastrous policy of negative interest rates which have apparently been considered by some, but so far not adopted.

Comments

Jim said…
Interst rates so low for so long, Tax on savings, Inflation targets of 2%, help to buy schemes, its like successive governments have done every thing possible to discourage saving and financial responsibility and encourage debt and borrowing.

Negative interest rates are just these insane policies stepping up to a new level.

Of course the whole house of cards will come crashing down in the end. I know people who are terrified of interest rates raising by 1/2 a percent, due to mortgage payments becoming unafordable, so you have to ask, well why did you buy such an expensive home if you cant afford it, of course they all answer that they can afford it so long as interest rates dont raise, which of course means they cant afford it. But they were encouraged to buy it.

A lot of policies like this are utter madness in the cold light of day, we see it throughout history that fiat currencies and debasement (very similar effect to negative interest rates) always, with out exception, always fail. We often have seen historically that someone comes along with a method to make it work this time ---"I have said it before and will say it again Mr Speaker, no return to boom and bust"---- er yeah.

It never has worked, ever, so why will it work this time?

insanity - doing the same thing over and over and expecting different results
Jim said…
I guess Thomas Edison got it spot on-

1. I have not failed. I’ve just found 10,000 ways that won’t work.
Jim said…
Its only when we look at things in terms of money that at first glance, sane policy seems bad.

lets say I earn 20,000 per year, and a Shop at tesco and to fill the car costs me 200. ok we can do that

now I only earn 2,000 per year, and a shop at tesco and to fill the car costs me 20, now I dont care.

I have stated before and will again, no one wants more money, which again at first glance looks like a stupid statement, but its not. What people who say they want more money really mean is they want more things they believe they can exchange money for.
Its only when we think, oh wow, I am now earning ten times as much as i used to great. No one looks at "but things are 15 times the price" that simple fact escapes so many people.
Jim said…
its something i have often thought about. I usually conclude that it's our very mortality that gives us reason, it gives us a means to an end. There are a million and one rich people in the cemetery, and in that respect then like the green and labour definition, life is indeed fair.

so there we have it, life is indeed fair, you cant take anything with you.

So well, governments, of whatever colour, should just leave me alone to make the best of the time I have, leave me be, my time will end, and well I wont take it with me I promise

Chris Whiteside said…
I agree with most of what you say - we both agree that negative interest rates are insanity, that money is not the issue but what it will buy, that debasing the currency leads to inflation if not hyperinflation.

You would probably enjoy a very funny fictional example of how some people are prey to what Maynard Keynes called "Money Illusion" - they cannot see past the nominal value of their income or wealth - in Mark Twain's novel "A Connecticut Yankee at King Arthur's Court."

I think though that your view on whether things have "always failed" depend on exactly what you are talking about and how you define success and failure.

I think there is enough on what history shows about economic claims and strategies which have always worked or failed to justify a new thread ...

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