The sudden end of the Fed’s ambition to raise interest rates above the
zero bound, coupled with the FOMC’s minutes, which expressed concerns about
emerging market economies, has got financial scribblers writing about
negative interest rate policies (NIRP).
Coincidentally, Andrew Haldane, the chief economist at the Bank of
England, published a much commented-on speech giving us a window into the
minds of central bankers, with zero interest rate policies (ZIRP) having
failed in their objectives.
Of course, Haldane does not openly admit to ZIRP failing, but the fact
that we are where we are is hardly an advertisement for successful monetary
policies. The bare statistical recovery in the UK, Germany and possibly the
US is slender evidence of some result, but whether or not that is solely due
to interest rate policies cannot be convincingly proved. And now, exogenous
factors, such as China’s deflating credit bubble and its knock-on effect on
other emerging market economies, are being blamed for the deteriorating
economic outlook faced by the welfare states, and the possible contribution
of monetary policy to this failure is never discussed.
Anyway, the relative stability in the welfare economies appears to be
coming to an end. Worryingly for central bankers, with interest rates at the
zero bound, their conventional interest rate weapon is out of ammunition.
They appear to now believe in only two broad options if a slump is to be
avoided: more quantitative easing and NIRP. There is however a market problem
with QE, not mentioned by Haldane, in that it is counterpart to a withdrawal
of high quality financial collateral, which raises liquidity issues in the
shadow banking system. This leaves NIRP, which central bankers hope will
succeed where ZIRP failed.
Here is a brief summary of why, based on pure economic theory, NIRP is a
preposterous concept. It contravenes the laws of time preference, commanding
by diktat that cash is worth less than credit. It forces people into the
practical discomfort of treating physical possession of money as worth less
than not possessing it. Suddenly, we find ourselves riding the train of macroeconomic
fallacies at high speed into the buffers at the end of the line. Of course,
some central bankers may sense this, but they are still being compelled
towards NIRP through lack of other options, in which case holding cash will
have to be banned or taxed by one means or another. This would, Haldane
argues, allow them to force interest rates well below the zero bound and
presumably keep them there if necessary.
One objective of NIRP will be to stimulate price inflation, and Haldane
also tells us that economic modelling posits a higher target of 4%, instead
of the current 2%, might be more appropriate to kick-start rising prices and
ensure there is no price deflation. But to achieve any inflation target where
ZIRP has failed, NIRP can be expected to be imposed for as long as it takes,
and all escape routes from it will have to be closed. This is behind the Bank
of England’s interest in the block-chain technology developed for bitcoin,
because government-issued digital cash would allow a negative interest rate
to be imposed at will with no escape for the general public.
Fortunately for the general public this remedy cannot be implemented yet,
so it can be ruled out as a response to today’s falling stock markets and
China’s credit contraction. What is deeply worrying is the intention to
pursue current interest rate policies even beyond a reductio ad absurdum,
with or without the aid of technology.
In considering NIRP, Haldane’s paper fails to address an even greater
potential problem, which could easily become cataclysmic. By forcing people
into paying to maintain cash and bank deposits, central bankers are playing
fast-and-loose with the public’s patient acceptance that state-issued money
actually has any value at all. There is a tension between this cavalier
macroeconomic attitude and what amounts to a prospective tax on personal
liquidity. Furthermore, NIRP makes the hidden tax of monetary inflation, of
which the public is generally unaware, suddenly very visible. Already ZIRP
has created enormous unfunded pension liabilities in both private and public
sectors, by requiring greater levels of capital to fund a given income
stream. Savers are generally unaware of this problem. But how do you value
pension liabilities with NIRP? Anyone with savings, which is the majority of
consumers, is due for a very rude awakening.
We should be in no doubt that increasing public awareness of the true cost
to ordinary people of monetary policies, by way of the debate that would be
created by the introduction of NIRP, could have very dangerous consequences
for the currency. And once alerted, the public will not quickly forget. So
not only are the central banks embarking on a course into the unknown, they
could also set off uncontrollable price inflation by creating widespread public
aversion to maintaining any cash balances at all.
The only reason any particular form of money has exchange value is because
people are prepared to exchange goods for it, which is why relative
preferences between money and goods give money its value. Normally, people
have a range of preferences about a mean, with some preferring money relative
to goods more than others and some preferring less. The obvious utility of
money means that the balance of these preferences rarely shifts noticeably,
except in the event of a threat to a complacent view. For this reason,
monetary inflation most of the time does not undermine the status as money of
central bank issued currency.
The trouble comes when the balance of these preferences shifts decisively
one way or the other. At an extreme, if no one wants to hold a particular
form of money, it will quickly become valueless, irrespective of its
quantity, just like any other unwanted commodity. This is the logical outcome
of negative interest rates, and subsequent increases in interest rates
sufficient to stabile the purchasing power of currencies is no longer an
option, given the high levels of public and private debt everywhere.
Therefore, we need to watch closely how this debate over NIRP develops. If
the Bank of England is looking at ways to overcome the zero bound on a
permanent basis, it is a fair bet that it is being looked at by other central
banks in private as well. And if NIRP gains traction at the Top Table, the
life-expectancy of all fiat currencies could become dramatically shortened.
* How low can you go? – Speech given by Andrew Haldane at the
Portadown Chamber of Commerce, Northern Ireland.
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