Can we stop interest-rates falling and going negative?

This week has seen a development I have long-expected and forecast. That is that the establishment will respond to the next economic slow down with negative interest-rates. The rationale for that is in one sense simple as in most places interest-rates never went back up again and if they did by not much, Only yesterday I looked at my own country the UK where in the decade or so since the credit crunch the Bank of England has raised interest-rates by a net 0.25%. Not much is it? Last time around the only reason it did not cut interest-rates even lower it was because it feared that the creaking IT systems of the UK banks could not take it. As it was some mortgages ( mostly with Cheltenham & Gloucester if I recall correctly) went below 0% and were dealt with via capital repayments to stop a HAL 9000 style moment.

Of course more than a few central banks continue to have negative interest-rates as we look at Denmark, the Euro area, Japan, Sweden and Switzerland. The ECB may pause this morning to mull whether it will get its deposit rate ( -0.4%) back even to zero as it note German factory orders some 7% lower than the previous year in December. This brings us to the driver of the current situation which is the economic slow down we have been following and indeed predicting via the decline in money supply growth. That remains as a slow down and has not yet signalled an overall recession but none the less it has produced quite a change.

The San Francisco Fed

It is far from a coincidence that the San Francisco Fed has produced a paper on negative interest-rates this week. After all the overall Federal Reserve has put up the white flag on interest-rate increases as we wait to hear what was discussed when Chair Powell had dinner with President Trump on Monday night.  Anyway the paper seems to open with a statement of regret.

Traditionally, it has been assumed that nominal interest rates cannot fall below zero, known as the “lower bound.” Ever since 2008, researchers have debated how much monetary policy was constrained by this lower bound and how much it affected economic outcomes. To work around this constraint, the Federal Reserve turned to unconventional monetary policy tools such as forward guidance and large-scale asset purchases.

Also an admission that QE was driven by the belief that interest-rates could not go below zero. I cannot be too churlish about that because there was a time when I did not think so either at least on a sustained basis although it was around 20 years ago and before the full impact of the Japanese lost decade! I do not know if one of the drivers of this thought was fear of what negative interest-rates would do to the US banks but history has seen a potential revision.

In this Economic Letter, I consider whether pushing rates below zero would have improved economic outcomes in the United States in the aftermath of the financial crisis.

For a central banker the answer is clearly yes.

Model estimates suggest that reducing the effective lower bound for the federal funds rate to –0.75% would have reduced economic slack by as much as one-half at the trough of the recession and sped up the ensuing recovery. While the boost to the economy would have been negligible after 2014, inflation would have been higher throughout the recovery by about half a percentage point on average.

There are various points here. First the central banker assumption that higher inflation is a good thing whereas in reality the ordinary person is likely to be worse off via lower real wages. Next the interesting observation that it is a temporary gain. Finally there is a later reference to Switzerland which took interest-rates to -0.75% so we are left with the view that this paper might recommend even more negative rates if only someone else had been brave/silly enough to try them. It omits to point out that Switzerland has not escaped from this as it is still at -0.75%.

How does this work?

An old friend appears.

In the model, the output gap falls with the interest rate.

Ah so it works because we assume it will. What could go wrong? Whilst we are at the Outer Limits of fantasy why not throw in the kitchen sink.

However, expectations about the future path of the fed funds rate matter, including any Federal Reserve announcements about its path—known as forward guidance—as well as expectations about being at the zero lower bound.

I am not sure if that is chutzpah, ignorance or just simple Ivory Tower non-thinking. After all we have just had a Forward Guidance U-Turn so are we following the old or new versions and if so what was the cost of the change? Those who have fixed their mortgage expecting higher interest-rates for example. Whereas now Men at Work are being played.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Rather oddly the paper says that the output gap is pushed higher when the author must mean lower, But there is a bigger space oddity which is this.

According to these simulations, the negative lower bound would have reached its maximum effect in the first quarter of 2011. Setting the lower bound at –0.25% would have increased the output gap by 1.5 percentage points, while pushing the lower bound down further to –0.75% would have contributed an additional 0.4 percentage point to the output gap. This means that a rate of –0.25% would have done most of the job, and allowing it to drop further would have accomplished fewer additional benefits.

Let us subject that to a sense check because we know that the US Federal Reserve did cut its official interest-rate to 0% ( technically 0% to 0.25%) but that going a mere extra 0.25% would make much of a difference? From the previous peak the US had cut by 5% so would an extra 0.25% make any difference at all?

The IMF goes further

Here we go.

One option to break through the zero lower bound would be to phase out cash.

It wants to go as Madonna would put it, deeper and deeper.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today.

They need a tax or fine or cash to achieve this.

Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year.


There is quite a bit to consider here but let me start with the concept of arrogance. This is because monetary policymakers have had the freedom over the past decade to do pretty much what they liked and if it had worked we would not be here would we? Yet like Jose Mourinho in the football transfer market they always want more, more, more. Actually I am being a little unfair on Jose as there was a time his policies brought plenty of success.

Combined with this is an obsessive clinging onto failed past concepts. The output gap has had a dreadful credit crunch yet here it is again. Next the idea that higher inflation is good has ( thank God) had a bad run too but central bankers confuse what is good for the banks with what is good for the rest of us. The reality that no country or economic area has gone into negative interest-rates and then recovered is simply ignored whereas so far they have all sung along with Muse.

Glaciers melting in the dead of night
And the superstars sucked into the super massive
Super massive black hole
Super massive black hole
Super massive black hole
Finally is the idea that those who do not worship at this particular monetary altar need to be punished. Just like in the novel 1984……

29 thoughts on “Can we stop interest-rates falling and going negative?

  1. Hi Shaun
    Very interesting as usual. A couple of points
    1. The idea that these microscopic movements can be directly translated into tiny movements in growth etc seem spuriously accurate at best
    2. Watching the BBC series on the EU (Ten years of turmoil) makes you realise that the club of top people making all the decisions don’t really take them on economic grounds, but political ones. In “saving” Greece and the euro, the discussion related almost entirely to what the German taxpayer would think of it…
    I guess that they feel (laughably in my opinion) that all this interest rate stuff is a technical matter for the “independent” central banks

    • The unintended consequences of QE and ZIRP have led to Brexit and so called populist anti EU/ establishment parties.

      NIRP will guarantee people like Corbyn taking control.

  2. Hello Shaun,

    from this

    “Suppose also that the central bank announced that cash-dollars
    would now become a separate currency that would depreciate against
    e-dollars by 3 percent per year. The conversion rate of cash-dollars
    into e-dollars would hence change from 1 to 0.97 over the year.”

    I guess I’m right in that they haven’t thought this through …….

    Massive out flow of cash from Banks to safe currencies , including gold, silver and diamonds, or any crypto currency …

    capital controls would be needed

    Local currencies would get a boost – so they’d have to ban them too

    Amazon and Ebay or any mostly online store will collapse, not the other way around

    if you remove the last vestiges of faith in any currency it will vaporize.

    I sometimes wonder if they took the South Park joke as a text book example………


    • Forbin, can I add ‘houses’ to your list of ‘safe currencies’, even classic cars and wine etc. Couldn’t make it up!

    • Not to mention the destruction of savings and pension pots built up over decades – de-flationary!!!, this of course would be ignored by the Alice In Wonderland economists who would probably say it would be offset by the capital created from new loans(inflationary), which of course benefit the precious so a win win for them.

      • Reminds we of when Haldane lectured a group of people (who were reliant on savings interest for income) the ‘you should not expect a return and therefore you should be dipping into your capital to get by’

        This coming from a guy with an RPI index linked pension for life earned by doing who knows what too

    • Hi Forbin

      So far all of the ten IMF Managing Directors have been from Europe and five including the current one Christine Lagarde have been French. Some have an especially dodgy history headed by Rodrigo de Rato of Spain (2004-07). From Reuters a year ago.

      ” Former International Monetary Fund chief Rodrigo Rato was sentenced to 4-1/2 years in prison by Spain’s High Court on Thursday following a scandal over the widespread misuse of company credit cards during his tenure at lender Bankia.

      Rato, who was economy minister in Spain and a prominent figure in the ruling People’s Party (PP) before moving to the IMF, chaired Bankia for two years until just before its state bailout in 2012.

      He had been on trial along with 64 other executives and former board members of Bankia and its founding savings bank Caja Madrid.

      The case is one of several high-level corruption investigations now coming to fruition and seen as a test of whether Spain’s rich and powerful are accountable to the law.”

  3. Shaun, this is simply stunning – thanks for exposing it.

    Firstly, I’m pleased their model suggests that negative interest rates would have reduced the recession and speeded up the recovery when the real-world example (the Eurozone) proves the exact opposite. The ECB can’t even get a recession right according to this!

    Secondly, doesn’t printing money (QE) depress market interest rates? And how would a negative interest rate affect the cost of debt differently?

    Thanks for another excellent blog post.

    • Hi DD

      No problem. As to your question QE does overall lower bond yields although exact evidence is never entirely conclusive mostly because markets adjust in advance of it. A lower interest-rate makes QE cheaper as the Bank of England has charged the project Bank Rate ( mostly 0,5%) on it although it is to some extent the mathematical equivalent of semantics.

  4. I have a simple question for advocates of a negative interest rate, where has it been shown to work? We already know what works, fiscal stimulus but then the capitalists and banks would have to compete for the extra spending power and we can’t have that can we?

    As to inflation, again this won’t be a popular notion on here, too much inflation is a good thing temporarily at least. This shows that there’s too much money in the economy and it needs to be taxed out. Sorry did I say tax? Now that we definitely can’t have.

    • “where has it been shown to work?”

      no where in the real world but they’ll love to try it !

      I mean , they’re Bankers , what could go wrong for the Masters of the Universe ?


    • Bill,
      It doesn’t have to work or be shown to have ever worked, all it is there for is to kick the can for a couple of years more, the people that propose such looney tunes policies are never questioned by mainstream media to explain or justify their theories and policies and never held to account by politicians for fear of compromising the “independence” of the central bankers, so what you have is a bunch of crazy academic/ economists let loose with the economic equivalent of giving a monkey a loaded machine gun trying to stop the western economic system (that is coming to the end of its natural life as a result of peak debt,) from imploding with ever more extreme policies instead of letting the system correct itself,, what as they say, could possibly go wrong?
      These people know the jig is up, but cannot accept or acknowledge the fact since to do so would also mean an alternative economic monetary system would likely be introduced that they might not be in control of, hence the ever more desperate policies being proposed.
      If you believe the New World Order “conspiracy theorists”, the next system has already been planned and this collapse is the pathway to it, if negative interest rates are introduced, it is because the time for the changeover is not quite there yet.

  5. Great article as always Shaun.

    They’re really pushing for the abolition of money, and I suspect the population will sleepwalk into it, without realising the effects. Recently whilst paying cash for lunch, the cashier without looking automatically lifted up the card machine. She seemed surprised I used cash.

    Most of the younger people I work with rarely use cash, straight onto the card. One day they’ll wonder why the state/banks are robbing them…

  6. Leaving aside the fact that banning cash would be a serious infringement of civil liberties and negative rates would be tantamount to outright wealth confiscation and the destruction they would wreak to pension schemes (finally finishing the job that low interest rates started), there are other factors – as if these were not enough!

    In addition negative rates would put our speculation driven economies into hyperdrive and guarantee a crash, something we need like a hole in the head.

    The quotes you give imply that monetary policy is the only game in town and that everything rests on that but of course it doesn’t, particularly when interest rates are at the ZLB. Keynes said that you are pushing on a string at the ZLB and all the evidence we have surely supports that hypothesis. At this point ii should be up to fiscal policy to take up the strain but where is the mention of this?

    The problem is of course that many central banks are now at least notionally independent and have no say over fiscal policy. Furthermore, in the EZ and the US, both driven by the neoliberal mindset, fiscal policy is anathema and any relaxation in terms of this would be seen as unacceptable hence the primacy of monetary policy. The fact that monetary policy may be inappropriate is of course neither here nor there.

    The sheer chutzpah and idiocy of these people is really breathtaking.

    • Hi Bob J

      Ironically the Donald is the one who has given fiscal policy a go. He may yet be proven to be right which will cause consternation amongst the MSM. However it turns out, with the US ten-year yield at 2.7% it is costing less than seemed likely at the time

    • define help

      it makes them spend spend spend , and that’s considered “help” by our Banking Masters

      Savers are not required in today’s modern debt economy , maybe even a bunch of evil, nasty, economy destroying, fascists that must be eliminated at all costs…..


  7. Surely this will speed up the demise of the dollar as the reverse currency.

    If/when it does happen the BoE will have to wait for the FED to do it first, so as not to totally destroy the pound.

  8. I have an extremely simple solution. Raise taxes to roughly post war levels and levy an annual Land or Wealth tax and spend the proceeds into the economy building decent homes, infrastructure etc. and getting that money into the economy as pay and trade. Maybe even pay down some debt whlst we’re at it – so that rates can rise again in the future. (Large debts press down on rate rises thru the Monetary Policy Transmission mechanism).

    BUT….that is not what the Davosniks want is it. They want a tax on ‘cash’….not ‘assets’. A tax on the little people by any other name.

    • Hi hotairmail

      One of the things that seems to have become regarded as unacceptable is outright tax rises. We did see some at the opening of the credit crunch with for example the rise in the VAT rate to 20%.

      Perhaps we could find a way of taxing the very wealthy as after all they have been the biggest gainers from the QE era.

    • I’m just an ordinary person but have spent 40 years saving out if after tax income. Yes I own two houses and have no debt but have paid for everything out of after tax income. I just don’t see why I should now pay further taxes out of what I have.
      I have no overseas trusts. I have no money except what I’ve earned. I don’t avoid taxes.
      I just don’t see why I can’t keep what I have after paying full taxes.

  9. Its of no surprise to me interest rates may go negative, as global growth slows things should become cheaper, this causes deflation.

    All things being equal which they aren’t in theory as the money on deposit loses its value on deposit through a penal rate it can in theory purchase more.

    Now I know there will be many saying ‘yes but look at property its unaffordable’ well all things don’t fall at the same rate.

    However the question was can we prevent a fall and even negative interest rates?

    Yes we can!

    If we use the UK as a model well we whip the workers to increase production at competitive prices, double output with only a 25% rate rise, which should mean consumer spend goes up, that should increase inflation as goods get in short supply.

    Higher inflation should then increase interest rates.

    SIMPLE ! lol

    If only life was that simple but its not.

    • Hi Peter

      I am in the camp that believes there were very few if any gains from cutting below around 1.5% but the establishment have locked themselves into this.Otherwise they have to admit that we are still in a mess a decade or so later,

  10. Shaun, CBs look for NIRP, left-leaning politicians embrace MMT. Is this totally inconsistent? Or in practice does NIRP have the same effect as taxation on inflation?
    Trump’s statement last night that the US would never be socialist made me smile, that happened some years ago.

  11. We probably don’t need to increase taxation of the very rich, simply getting them to pay their fair share and not hide everything in off-shore tax havens would almost certainly suffice for now.
    But I am dreaming. The current and previous Prime Ministers families are both up to their necks in the off-shore tax avoidance industry, recent cabinets had few non-millionaires, and it’s the Elite (aka the wealthy) that seem to set (or block) any tax agenda and it’s associated laws.
    Maybe a Corbyn government will finally bite the bullet and introduce fair taxation for all, possibly along the lines of equal representation for equal taxation? 😉

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