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Press, Journal Article
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The thing is, when operating below the zero lower bound, monetary
policy is laid bare: it “works” by eroding your purchasing power in a
more direct way than ever before. In the end, we doubt NIRP will
help boost the economy.
TEXTBOOK THEORY: THE LOGIC OF POSITIVE
INTEREST RATES
Here’s a challenge for you: go down to the nearest town square, pub,
or Starbucks and offer $10 bills in exchange for just a $1 bill. Try it;
we dare you.
At first, each passerby might think you’re crazy or a purveyor of coun-
terfeit bills. But, soon, they may take you up on the lucrative offer, as
$1 gets them $10—a guaranteed return for little risk/effort.
Then, on a subsequent day, try the opposite: ask for $10 in return for
$1. The only taker would have to be as crazy as you.
Nobody
wants to give up
more
today for
less
in the future.
The same intuition governs interest rates everywhere in the known
universe. Since nobody is going to lend money at a negative rate when
they can hold money at zero interest (in the form dollar bills, for ex-
ample), interest rates could never go below zero.
Don’t trust us? Take it from the pen of the godfather of modern eco-
nomics, John Hicks, writing in 1937,“If the cost of holding money can
be neglected, it will always be profitable to hold money rather than
lend it out, if the rate of interest is not greater than zero. Consequently
the rate of interest must always be positive.”
1
REALITY IS MESSY
Well, as it turns out, how low interest rates can go depends on the
key assumption from our friend Hicks that depositors, will in fact,
pull money out of the bank in the form of notes and coins that pay a
zero nominal rate rather than save in investments that yield less than
zero or lend money at a negative rate. But this assumption fails for
two reasons.
First, as recently observed by the Bank for International Settlements,
the actual implementation of NIRP equates to a tax or fee on a certain
type of central bank deposit. At the BoJ, for example, a three-tiered
system has been used, with only one rate a (barely) negative one, and
it applies to just 1-2% of bank reserves (See
Figure 1 on previous page
).
In Europe, the SNB originally instituted an exchange rate floor to
stem the cross-border capital tide from euros to Swiss francs in 2011.
In 2015, when the ECB renewed its easing program, the SNB aban-
doned the currency peg and opted for a new strategy to fend off un-
wanted currency flows: a negative deposit rate instead.
But the SNB’s move wasn’t all that new. In 1973 the SNB also insti-
tuted a “deposit fee” of 2% per quarter on deposits by non-residents
to stem the flow of capital into Switzerland that put upward pressure
on the exchange rate. The Swiss later upped the fee to 3% per quar-
ter in 1978. More broadly, for centuries central banks have raised or
lowered discount rates to encourage or discourage capital inflows and
outflows.
And that provides a good way of thinking about how negative rates
have been implemented thus far: as a tax or a fee on certain types of
deposits, namely those held at central banks. In short, the negative
rates are charged to deposits that one must hold—they couldn’t get
around it even if they tried by selling them to someone else.
You might wonder though about negative yields on government bonds
in Europe and Japan. Once again, these assets are “safe assets”—assets
that must be used for capital requirements, liquidity, regulatory and
collaterals purposes. As a study of US Treasury bonds reminded us,
investors holding such bonds do so not for the juicy yields, but “be-
cause safe asset investors have nowhere else to go but invest in US
government bonds.”
2
This was true when rates were at just above zero
and it remains true below the zero bound. There are no alternatives.
2
DID YOU KNOW?
The Textbooks Got It Wrong
We surveyed the top-selling macroeconomic textbooks.
In fact, the top-sellers are woefully out-of-date.The most
widely read introductory economics textbook in college,
Greg Mankiw’s
Principles of Economics
, discusses the
zero-lower bound of nominal interest rates.The textbook
declares that “nominal interest rates cannot fall below
zero: Rather than making a loan at a negative nominal
interest rate, a person would just hold cash.” Another
popular text by Paul Krugman and Robin Wells, entitled
Economics,
states that an interest rate below zero
“isn’t possible” and “nobody would ever buy a bond
yielding an interest rate less than zero because holding
cash would be a better alternative.” Hopefully the new
editions of these textbooks will fix these glaring errors.
Until then, use those college economics books you keep
as doorstops.