Nikolai LayneAs a new year approaches, we must reflect and carefully assess the uproot of a new financial era surfacing in the global economy. Research has revealed an interesting phenomena which must be dissected and challenged by economists, bankers and policy makers. The relevance of negative interest rates have been explored by Asian, European and American economies with varying views of its effectiveness as a monetary policy tool.
To unravel Negative interest rates, we must look at the underpinning money supply process and its functionality since the great recession in 2008. Over time a noticeable shared responsibility amongst commercial and central banks were established where the money supply is concerned. Historically, commercial banks would act as intermediaries involved in the process of taking deposits from savers and lend these excess funds to borrowers in need of capital for investment purposes. Presently there is a powerful shift where a positive correlation between the quantity of loanable funds and the availability of credit moves parallel with the money supply. Taking a look at the other side of the coin; central banks utilized tools such as monetary policy to control the availability of money in a given economy. Their aim is to implement a policy framework to achieve a healthy and sustainable economy. This framework is built upon macroeconomic criteria such as controlling inflation, consumption, growth and liquidity. The mechanics to make this possible rest in the required reserve, modifying the interest rate, transacting government bonds and regulating foreign exchange.
Unsustainable practices by commercial banks have caused a significant hike in credit which has led to a consumer driven global economy. Economic actors are willing to lean against their future earning potential by borrowing now for goods and services. Consumption at this level causes an increase in inflation (the rate at which prices increase in relation to a fall in the purchasing value of money). When a major financial shock occurs, the aggregate debt servicing ratio is affected causing an increase in default risk thereby affecting the economic health of a country. The opposite is also just as worrisome and usually flagged by Central Banks. Deflation is created when commercial banks adjust their interest rates due to a rise in the required reserves by the central bank. This event increases the cost of borrowing and causes a contraction of the money supply thereby creating a price competitive environment.
Negative interest rates came about as an economic recovery tool first discussed by theoretical economist Silvio Gesell (1980). In advent of the Great Depression (1929-1939) economists Irving Fisher and Maynard Keynes entertained the idea of using negative interest rates to stimulate consumption and investment. An introduction of these rates were rolled out by Governor Stefan Ingves of the Risksbank in Sweden (2009). The mandate for negative interest rates were originally pinned on commercial bank deposits held within the central banks. It’s purpose was to encourage commercial banks to find useful means to stimulate the economy with productive capital rather than having the money sitting in the Central Bank. Eventually savers were also affected where commercial banks decreased their interest rates to the lower bound and offered zero or negative rates on deposit accounts.
Countries are intrigued with this new policy tool whereby negative interest rates are now being implemented in all aspects of the financial system. Japan for example has issued these rates on their sovereign bonds and investors benefit by hedging against inflation and foreign exchange risk. This is possible since the Japanese yen is one the most stable currencies in the market. Having excess money in bonds is better than keeping it in a deposit account or the central bank. Unfortunately the average saver and investor are not the beneficiaries from this new phenomena due to asymmetric information. However, this does not mean that one can not benefit once exposed to the primary indicators and factors currently aiding governments, investment banks and venture capital firms to benefit from this opportunity.
In conclusion money has never been so cheap in the global economy. The disparity gap between the wealthy and the poor is widening. Those who had access and invested the trillions of dollars in new money created over the past decade are reaping significant rewards. But individuals who used the availability of credit on personal purchases which does not add value to their net worth will be severely affected by the next recession. According to a publication by the IMF, “the Gross World Product is estimated at eighty seven trillion dollars ($87 trillion)“, whilst Bloomberg projected the total World Debt at two hundred and forty-six trillion dollars ($246 trillion). In context a bubble has been created where the money supply has been inflated against its real value and this is an unstainable pattern which will inevitably lead to another financial crisis. The Bank of International Settlement has warned against the use of negative interest rates and reports that, “unconventional monetary policy runs the risk of eroding incentives for the private sector to buffer against financial stress.”