William Watson: How negative interest rates could spur more fear than growth

I have a proposition for you personally. Let me borrow $100. How much are you prepared to pay me for the privilege?

I know, I understand. The custom has long been that when I borrow money from you, I pay out interest. However in the upside-down, inside-out new world of “negative rates of interest,” which to date went farthest in Europe, you pay me. On some Danish mortgages, The Wall Street Journal reports, homeowners are now getting monthly obligations using their banks, not the other way round.

Negative rates of interest, that the Bank of Japan a week ago became the latest central bank introducing, have been in existence for a few years now. To get economies growing, central banks attempt to lower rates of interest. With lower borrowing costs, “real” investments in buildings, factories, bridges, you name it, which are prone to have a profit rate of five or 10 or 15 percent should be even more attractive.

If businesses can borrow money at a couple of or three per cent and use the proceeds to finance investments prone to pay off at several times that, they may well find the prospect irresistible. Hence, monetary easing promotes real economic growth. People get hired. Supplies get bought. Economies take out of recessions and begin delivering higher living standards.

Except that, since 2008, central banks have lowered and lowered and lowered interest rates, in many cases basically to zero, and growth continues to be anemic, particularly in Europe and Japan. In response, one recourse would be to cease working on rates of interest and just support large quantities of all kinds of loans, referred to as “quantitative easing.”

But another is to boldly go underneath the “zero lower bound,” as it’s called, and charge negative interest, as is being done in Sweden, Switzerland, Denmark, the eurozone and now Japan. Large banking institutions that deposit cash with central banks now purchase the privilege of doing so.

Why would anyone ever pay negative interest?

As forever in economics, it depends in your alternatives. In fact, banking probably started off with negative interest rates. Within the ancient realm of metallic currencies and widespread thievery, you might well wish to pay five per cent, say, to possess some security company store your gold in the vault and protect it from punctures for you.

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Once such operations determined all their customers never withdrew all their gold all at once, it wasn’t a reach for these to start lending some of it to people who were prepared to pay positive curiosity about to finance profitable ventures of 1 kind or any other. Eventually the “banks” themselves, because they came into existence called, started to offer positive interest to attract new depositors to keep the profitable lending going.

Why don’t banking institutions, or anyone else charged negative interest, just withdraw the money and keep it in cash?

Your $100 will likely be safe for the year if you don’t lend it to me. You can put it beneath your mattress. But when you’re a big financial institution with billions of dollars on deposit, how large a mattress can you get? Additionally, there are the problem, for us small-timers, that cash no longer works for many of the transactions you want to make. Ever try sending Amazon.com cash? Even if banks were charging us on our deposits, we might still need them. Besides, they charge us for anything else. Why not deposits?

Will negative interest rates work? This will depend what goes on towards the prospective returns on those “real” investments central banks want to encourage. When they hold up and because negative-interest finance cost less, the end result ought to be a lift to real economic activity.

But if the brave new looking-glass world of negative interest rates persuades potential investors everything is going to hell, those prospective returns by using it, then the policy backfires.

Fingers crossed as we all jump down this rabbit hole!