Negative Nominal Interest Rates: Just Say No – Gerald P. Dwyer (12/26/2019)

Official portrait of Governor Jerome H. Powell. Mr. Powell took office on May 25, 2012, to fill an unexpired term ending January 31, 2014. For more information, visit http://www.federalreserve.gov/aboutthefed/bios/board/powell.htm

Not willing to let a terrible proposal die, President Trump has reiterated his suggestion that the United States would be better off with negative nominal interest rates. In a line that generated laughter, he said, “Many [in the eurozone] are actually getting paid when they pay off their loan.… Who ever heard of such a thing? Give me some of that.”

Are private people and firms paid to borrow if central bank interest rates are negative? No.

Negative nominal policy rates at the central bank have not resulted in negative interest rates on loans at banks. In fact, it would be surprising if they did. The negative nominal interest rates are -0.5 percent at the European Central Bank (ECB), and the lowest rate at the Bank of Japan is -0.1 percent. The typical margin for loans at banks over the federal funds rate is more than 0.5 percent; there is no good reason to expect negative rates on short-term loans at banks.

Interest rates in the eurozone on government securities are negative though. That means governments are borrowing at negative interest rates.

Negative long-term interest rates on government securities might suggest that long-term loans such as mortgages might have negative rates. But they don’t. Even in the widely cited case of Denmark’s negative mortgage rate of -0.50 percent, it turns out that mortgages have a positive interest rate on the amount actually received. A $100,000 mortgage loan is discounted when originated; the borrower receives $95,000. 

Mortgages typically are made for 10 years in Denmark. The borrower does receive -0.5 percent per year on the balance over time, which is $500 per year initially and then falls with the loan balance. The total of the negative interest payments never equals the original discount of $5,000. In sum, the borrower pays to receive the loan of $95,000. This is even more true when other charges, including 0.3 percent per year, and fees are paid to the bank.

How are savers affected? Savers with deposits at banks could receive negative interest rates even if borrowers do not get to borrow at negative interest rates. Large depositors are receiving negative interest rates. Households with relatively small savings and checking accounts are not. Banks have lowered rates on small deposits to near zero and increased fees to try to reduce the negative effects on their profits, but they have not introduced negative rates on smaller deposits.

Why don’t banks charge interest on smaller deposits? Currency still has an interest rate of zero, and that is better than any negative interest rate on a deposit. Households can keep cash in a safe at home or in a safety deposit box at a bank. At a scale of $10,000 or even more, there is an obvious incentive to keep savings in currency at home or in a safety deposit box. Some depositors do not have to pay for safe deposit boxes. Even if there is a charge for the safe deposit box, it may be better than the negative interest rate on a deposit. Or a household can buy a safe and bolt it to the floor. This is not zero risk. But, relative to a negative rate, a zero interest rate may compensate for the risk. 

Not introducing negative deposit interest rates has lowered banks’ profits and their return on capital, but this can be better than large deposit outflows. The lower return on capital can create problems for banks though if negative interest rates continue long enough.

Negative nominal interest rates in the eurozone have created other distortions in banking. Regulations require that large banks hold substantial amounts of liquid assets. European banks with U.S. branches can hold some of those liquid assets at the ECB or at the Fed. The ECB charges 0.5 percent per year, and the Fed currently pays 1.55 percent per year. There is risk due to possible changes in the exchange rate between the dollar and the euro. 

However, a differential of over 2 percent per year apparently is enough to induce eurozone banks to take this risk. Eurozone banks hold about 40 percent of all the substantial amount of excess reserves at the Fed. They would not be bearing this risk if the interest rate at the ECB were close to the U.S. rate.

Besides these problems, negative rates in the U.S. could seriously disrupt short-term securities markets in the United States. Money market funds hold substantial amounts of Treasury securities and commercial paper. These money market funds are money market mutual funds. The investors in the funds receive the interest received by the fund less management expenses. If funds received negative interest rates on their holdings of short-term securities, that negative interest would be passed through to investors after management expenses are tacked on. 

While, as in the eurozone, large investors such as corporations might continue to hold funds in money market funds even if they were charged interest, many small investors would put the funds in bank deposits if banks did not charge interest. If banks began charging interest, a safe or a safety deposit box could become a good alternative. Either way, money market funds would have to sell some of their holdings of short-term securities with possibly serious disruptions in short-term securities markets.

To add insult to the injury of possibly paying to hold savings, as a recent op-ed in the Wall Street Journalpointed out, savers in the United States will be taxed more with negative interest rates if tax laws aren’t changed. Tax law is not prepared for negative interest rates. 

It is natural for an economist to think of prices as being positive or negative depending on circumstances. An obvious example is recyclable trash, for which payment might be made or a charge might be required to take it. The price can be positive or negative depending on demand and supply in the market for recyclable material. It is more complicated when the tax laws related to interest are involved. Negative interest rates were not contemplated when many tax laws were written.

Even if parts of the economy are helped by negative interest rates — and they may well not help any part other than the government — negative nominal interest rates create many problems. They would create even more problems in the United States than they have in the eurozone.


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