Negative Interest

A Glimpse Through the Looking Glass

This is odd: “about $3 trillion of assets in Europe and Japan … now have negative interest rates.” That means depositors have to pay banks to hold their money. Sounds like Alice in Wonderland.

Why would anyone agree to that? Why not just keep your money in the cookie jar or under a mattress? But Nouriel Roubini, the economist, called “Dr. Doom” for predicting the 2008 crash and subsequent depression, had some good answers to that question in his commentary on Project Syndicate. For one thing, those of us who maintain balances in our checking accounts without interest are doing virtually the same thing, when you factor in the depreciating effect of inflation. We may be losing a bit of money, but it’s safe in the bank, and it’s accessible. If we live in economies threatened with significant deflation, it makes even more sense. On the other hand, if you keep it at home, it could get lost or stolen or by eaten by mice.

The more interesting question is why would banks would want to offer negative interest? There are real limits to profitability as the rates are usually nominal, and I can’t imagine them relishing a competition with each other to pay out more.

Governments like it, however, especially in a time when economies are stagnant. It encourages people to spend. If there is a cost to parking your money in a bank, you’re more likely to buy that new car instead or take the vacation you’ve been putting off.

But at a time when there are powerful arguments to break up banks that are “too big to fail,” it is also a way to keep them under control and demonstrate their usefulness. Negative interest will not flood them with cash, encouraging them to speculate. Investors will be less inclined to expect them to generate outsized profits. And that together with regulations requiring them to hold on to more of their assets to cover potential losses (a topic I covered in my last post), it does a lot to restore banks to their traditional role of protecting against speculation and volatility.

That’s not being said, of course, as bankers have gotten used to using our money to make more money for themselves, no longer being content with their traditional, conservative role. They are not actually arguing for negative interest – or, even, offering it to their customers, at least in this country. It’s just not profitable enough.

But it would make our financial system more secure. It also sends a message that money isn’t just an opportunity to make more money, and that bankers can be more than just “a lot of mouths with expensive tastes,” as Warren Buffet characterized them a few days ago.”

Negative interest will not have a major impact on our financial system. Roubini reminds us that solving our economic problems would require far more significant efforts: “central banks and fiscal authorities need to pursue policies to jump-start growth and induce positive inflation.” That would require “fiscal stimulus, especially public investment in productive infrastructure projects, which yield higher returns than the bonds used to finance them.”

But it might get us all thinking.