An interesting article out of the New York Federal Reserve entitled "If Interest Rates Go Negative....Or, Be Careful What You Wish For" takes a look at the scenario of negative interest rates and how these rates would impact the economy and consumers.
As shown on this graph, for each of the eight recessions that America has experienced over the past five decades, the Federal Reserve has used falling interest rates (in red) to prod the economy back to life:
Notice that, since 1980, the background interest rate during expansions (in green) has dropped to lower and lower levels, most notably in the period since 2008 when interest rates were pushed to near zero. Despite that, the economy is barely growing and unemployment remains elevated. This has led some people to suggest that the Fed should push short-term rates into negative territory, yet another experiment along with the already ineffective QE and Twisting.
The Fed could best accomplish this by charging interest on excess bank reserves rather than paying interest. The Interest On Excess Reserves or IOER currently sits at 0.25 percent. It is this rate that is the benchmark for Treasury Bills, commercial paper and interbank lending. By lowering this rate further or pushing it into negative territory, banks would have less incentive to keep deposits with the Fed and may be more willing to loan the funds thereby stimulating the economy.
According to the authors of the analysis, Kenneth Garbade and Jamie McAndrews, IOER rates below negative 0.50 percent would present problems for banks because their products and services would be used in ways that are not expected. As cash from money market funds flooded into banks, they would likely be forced to charge depositors for holding onto their cash, essentially creating a negative yield. The Bank of New York Mellon has already taken steps toward charging a fee to depositors with large cash balances as shown here. As well, demand for certain Treasuries would spike as investors sought yield, pushing the price up and yields down further, resulting in even greater distortions in the bond market.
Here are some of the impacts of negative interest rates and tactics that consumers and businesses may use to avoid losing money on their savings:
1.) Some analysts suggest that negative rates are not possible since investors will choose to hold cash. While that may be possible for smaller investors like you and I, it is not possible for corporations and various levels of government who would be holding billions of dollars in physical currency. That said, smaller businesses and individuals who elect to hold cash would pressure the Treasury Department to print more physical currency as demand for paper bills rose.
2.) Special-purpose banks would likely be created. These banks would offer conventional checking accounts for a fee and would pledge to hold no assets other than cash, held in a vault. Checks written on these banks would essentially be a receipt on the cash held by the bank.
3.) Individuals may choose to make large excess payments to the IRS, counting on collecting the overpayment the following April. This would avoid losing money on negative interest unless, of course, the IRS implemented a negative interest rate policy on overpayments.
4.) Individuals may also choose to make large excess payments on their credit cards, running down the balance as they make purchases.
5.) Rather than depositing checks received from governments, businesses or other individuals immediately, recipients may find it more prudent to avoid negative interest rate charges by simply not cashing the checks immediately.
6.) Consumers and businesses will have more incentives to make payments on outstanding credit balances quickly over a shorter period of time and receive payments on such credit balances more slowly over a longer period of time. This is completely contrary to the current system that demands payment on credit as quickly as possible. This will pose problems for a system that has evolved in an environment where "time is money".
As we can see from this analysis, a Federal Reserve-implemented negative interest rate environment would result in an intriguing set of issues for the American economy, the banking sector and consumers. While it is highly unlikely that such an environment will occur, ten short years ago, no one would have ever thought that the Fed would have pushed interest rates down to a fraction of a percent for a three year period.
Never say never.