Do negative interest rates help economies?

In the modern economy, the central role of central banks is to control the amount of money in circulation. The right policy in this area ensures confidence in money and price stability. The main tool for the central bank is the short-term interest rate. The consequence of its reduction is the increase in the amount of money in circulation due to the fact that commercial banks, being able to borrow cheaper, borrow more. The opposite is true if the interest rate increases. Such a step helps central banks fight inflation.

It is widely believed that lowering interest rates and increasing the amount of money should lead to greater economic activity. Knowing this, the authorities of various countries willingly try to stimulate the economy in this way, the more so that the cost of such an operation is small.

The effect is easy to predict. Interest rates in most developed countries are close to zero. Further lowering them makes no sense, the more that the effect is meager. Increasing also because it can lead to recession.

Negative interest rates

Ten years ago, the central bank of Sweden - Riksbank, was the first in the world to introduce a negative short-term interest rate. Commercial banks had to pay for the possibility of keeping deposits with the central bank. This was to make banks lend to entrepreneurs and consumers instead of depositing it with the central bank. It also happened. Banks extended their lending to such an extent that it began to threaten their financial results. Profitability of the entire sector dropped significantly. At the end of 2019, Riksbank decided to raise its most important interest rate to zero.

Negative interest rates are currently used in Japan and Switzerland. This seems especially dangerous in the latter country. SNB - Swiss central bank issues huge amounts of its currency and buys with them foreign financial instruments. The amount of Swiss francs in circulation in relation to the size of gross domestic product is about twice as much as in the United States and the Eurozone. Switzerland has a relatively small economy, more or less the size of Poland, which means that in the event of a crisis it may be susceptible to manipulation. The crash of the Swiss franc can occur at any time, and Switzerland will welcome him as it will increase the profitability of exporting goods, services and advanced technology.

Money surplus

Are negative interest rates just a figment of central bank economists? Not necessarily. The current yield on German 10-year bonds is -0,212%. And neither German government nor central bank sets it. It is determined by the market. It turns out that there is so much money in the developed world today that financial institutions are ready to pay to get rid of their responsibility for a moment. Apparently, they see no more viable alternatives, and their customers will bear the costs.

Since interest rate cuts have ceased to affect the economy, economists are inventing newer and newer methods of reviving it. Quantitative loosening, credit or so-called helicopter money (this concept assumes payments from the central bank directly to citizens). However, apart from issuing money, the authorities have at their disposal another instrument that can revive the economy - tax cuts. They use it reluctantly, because, unlike printing money, it is expensive for state budgets. However, if the whole highly developed world falls into the trap of zero growth, zero interest rates and zero inflation, there will be no way out.

Author: Paweł Kruszyński - Member of the Management Board of Investment Assay