Samuel Felling

 

In the last 8 years, we have seen how negative interest rates have gone from a theoretical improbability to a reality. From Japan to Switzerland, among others, various countries have now adapted monetary policy to include negative interest rates. The debate now partially shifts from whether there is a zero lower bound, to how effective negative interests rate can be.

Negative interest rates (on reserves) theoretically should incur short term growth in the economy. This is due to the passed down effects of banks. Banks will instead attempt to limit the amount of excess reserves that are in on their accounts, and will attempt to turn those reserves into loans. As such the extra loans made should amount to additional short term growth in the economy. This could be highly beneficial since inflation has been stagnant, low, and historically below target in recent years since the great recession. While in the past few months starting 2017, inflation has seen a spike, it still could be beneficial to  adopt negative interest rates. Short term growth due to the negative rates may be what gets this administration into an expansionary period.

Currently President Trump has called for massive tax cuts, for businesses and wealthier individuals. The classic story goes that these cuts will “trickle down” from the wealthier class to the middle and lower classes. Additionally, Trump has called for an spending in the form of military and infrastructure.  While he has said that he would cut money from other agencies to make way for the additionally spending a simpler solution may be easier. While tax cuts may have growth of output in the short run as well, and the revenue lost may be offset by revenue in other forms, the safer approach would be to simply adopt negative interest rates on reserves. This is since both currently proposed policies by Trump would incur additional deficit spending.  Deficit spending is often important in pushing an economy back on track and usually the deficit is paid for once in turn the economy is in an expansionary period. However the U.S deficit has been shrinking in recent years and a reversal of recent policy may be unwise.

If the monetary authorities decided to put into place negative interest rates, the effects could be multiple. First as stated earlier growth in the short run should be incurred. This could be a way to incur the additional output sought out, without the additional losses in revenue that would be likely due to expansionary fiscal policy. Additionally the treasury would not have to pay banks now the billions they are paying them for interest on reserves. The 1 percent rate at which all reserves are being paid, would disappear and again this is money saved by the government while still shocking output. While this type of policy could be open to additional systemic risk in the market, it could still be useful in the short term.

There may be additional effects on the economy that must also be accounted for however. The first would be how negative interests rate would likely deflate the dollar. This in turn could make exports cheaper and likely not only be a boon to the economy, but can help bring jobs back into the U.S.

However if may countries adopt negative interest rates, comparatively the weakening of the dollar may have little effect since “First, currencies of countries outside the OECD are depreciating as well, the benefits of a strong dollar in terms of enhanced exports from counterparty countries could flow to them rather than the beleaguered European economies.” On the other hand, if the dollar is not weakened compared to other countries, exports can be continuously decreased and more jobs lost which “Second, having won an election on a platform that promised to increase jobs in America and keep them away from migrants, the Trump administration would be under pressure not to hand over the benefits of an improving economy to foreigners. If the rising dollar does lead to falling exports from the US, protectionism is a real possibility.”

Long term adoption of negative rates may be discouraged however. While there is little econometric evidence behind negative interest rates, some research has shown some negatives in the long run. First because banks will be forced to make loans to borrowers (the whole point of negative rates) with both good and bad net return value, there will be non- performing loans in the long term. “Indeed, empirical research shows a clear negative relation between economic growth rates and non-performing loans.”  The losses incurred by the non-performing loans along with the fact that in the long term banks may be forced to rethink their business model due to long term rates, it may be wise to use negative interest rates in the short term only. In fact some OLS estimates have found an insignificant relationship between growth and negative interest rates. Savaging’s rate actually increased in these estimates, contrary to popular belief. While human behavior is often unable to be fully put into an equation, and OLS estimates as such cannot fully capture the full picture, it is still significant to note.  Perhaps Mankiw’s theoretical proposal of having the treasury making certain denominations of bills randomly worthless, so people instead will choose to spend their money could be an alternative. However, as that proposal is likely to not garner any popularity any time soon, it is not all that likely. As such negative interest rates could be a useful short term tool to raise growth and output while still maintaining a balanced budget.  In the long term though no evidence supports adoption of these rates and may in fact be imprudent.

Should the U.S Adopt Negative Interest Rates?