Wednesday, November 4, 2015

Negative Interest Rates........VERY IMPORTANT!

Negative Interest Rates

Since the financial crisis, the world's understanding of economics has been undergoing rapid change. Ideas that would have been considered crazy just a decade ago are now seen as much more likely, acceptable in the mainstream of economics.

One of those ideas is that central banks could bring in negative interest rates.

Growth is tepid around the world, and in many advanced economies, inflation is nowhere to be seen. Cutting interest rates is a typical tool for stoking inflation and growth. 

What else can be done when rates are already pretty much at zero?

A handful of countries have already said goodbye to ZIRP (zero interest rate policies) and hello to NIRP (negative interest rate policies).

Switzerland instituted negative rates in the 1970s in an attempt to deter a flood of foreign investment, while in 2009 Sweden's Riksbank became the first central bank to implement a negative interest rate in the aftermath of the financial crisis.

The Swiss National Bank, Danmarks Nationalbank and European Central Bank have since joined the Swedes, setting some of their policy rates in negative territory.

At the moment, no central bank interest rates are very deeply negative. For example, the ECB deposit rate is at -0.20%. That's the overnight rate which banks get for storing their money at the ECB, but they'll offer consumers with deposits a considerably higher rate than that. The central bank rates would have to be much further below zero before ordinary bank accounts got negative rates too.

The widely understood problem with NIRP is that if you forced negative interest rates on consumer deposits, depositors wouldn't just be losing out in real terms from inflation, they'd actually see the numerical amount of money they hold falling. 

There's a well-known concept called money illusion in economics, which among other things, explains that people are extremely resistant to losing out in nominal terms.

Money Illusion

In economics, money illusion, or price illusion, refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of money is mistaken for its purchasing power (real value) at a previous point in the general price level (in the past). This is false, as modern fiat currencies have no intrinsic value and their real value is derived from all the underlying value systems in an economy, e.g., sound government, sound economics, sound education, sound legal system, sound defence, etc. The change in this real value over time is indicated by the change in the Consumer Price Index over time.

Money illusion can also influence people's perceptions of outcomes. Experiments have shown that people generally perceive an approximate 2% cut in nominal income with no change in monetary value as unfair, but see a 2% rise in nominal income where there is 4% inflation as fair, despite them being almost rational equivalents. Furthermore, the money illusion means nominal changes in price can influence demand even if real prices have remained constant.


An unadjusted rate, value or change in value. This type of measure often reflects the current situation, such as the current price of a car, and doesn't make adjustments to reflect factors such as seasonality or inflation, which provide a more accurate measure in real terms.

Google Trends in "negative interest rates" over time.

If people could actually see the money in their bank accounts declining, they might well simply withdraw it and store it as cash. That's the crux of the "zero lower bound" problem, and why most central banks had previously never really considered cutting their own rates into negative territory, or won't go very far with it even if they do.

But Miles Kimball, professor of economics at the University of Michigan, explains that flight to cash could be prevented in the latest economic review from the National Institute of Economic and Social Research (NIESR), published Wednesday. Clearly, bringing in negative interest rates on electronic money isn't the problem, that's just a matter of setting them.

Kimball argues that the value of various units of cash is determined by the central bank: The Federal Reserve, in the case of the US. He says that two $10 notes are worth one $20 note because the Fed says so, and it's willing to swap the notes for those amounts when a commercial bank asks.

But if the Fed simply refuses to take cash at its printed value, that poses a major problem for ordinary banks. Kimball suggests that the Fed imposes a negative interest rate at the cash window (where banks switch up the physical cash they possess), or charge a fee to have the same effect. So the Bank of England, or the Fed, or the Bank of Japan simply wouldn't offer the same amount of electronic cash for the notes deposited.

There'd be a reduction in the value of paper money over time. for example, if there was a -4% rate (which Kimball uses as an example), a bank trying to hand over $100 would get $96 back in e-money after a year, or $92.16 the year after that.

It's easy to see how this would make cash less valuable to banks, and how the effect could trickle through into the real economy. If banks stopped accepting paper currency at face value from businesses, why would businesses accept it at face value from customers?

To clarify, Kimball doesn't suggest in his paper that this method should be used to abolish cash. In his writing, it's just a way of bringing in negative interest rates without a flight to cash. It would apply the same pressure to physical money as is being applied to electronic money in bank accounts.

The real value of the electronic dollar (or pound, or whatever) stays the same, but if you hold it in a bank, the actual numerical value is reduced. The face value of the paper dollar (or pound) can't be changed — a $10 bill stays a $10 bill — but its real value is falling against the electronic currency.

But if you did want to practically abolish cash, you'd just need a small tweak. In fact, all you'd need to do is make that negative interest rate at the cash window more steeply negative than the one people were getting on their electronic money. The effect economists fret about from NIRP policies, the flight to cash, would then be reversed, and there'd be a deliberate flight to electronic money.

Sweden is one of the most advanced countries in the world in terms of the decline of cash, and it's also got (shallow) negative central bank interest rates. There are even rumours of people stashing cash in their homes because banks aren't interested in taking it.

Cash is valuable to some extent because it's fungible — exchangeable for an identical unit — and liquid.


A good or asset's interchangeability with other individual goods/assets of the same type. Assets possessing this property simplify the exchange/trade process, as interchangeability assumes that everyone values all goods of that class as the same.

But this proposal would quickly end that, and split electronic money and paper money into two effectively different currencies. Paper money would be depreciating in value more quickly than electronic money. In effect, paper money would have higher inflation than electronic money.  THE MARK OF THE BEAST IS COMING, JUST AS THE BIBLE SAYS!

The zero lower bound is a construct some economists might be happy to smash through, but it's far less popular among savers. Many people see the abolition of cash as a massive government intrusion into their financial freedom: It's much, much easier to track what someone is doing with a credit card than with a pocket full of banknotes.

However uncomfortable you are with the idea, you'd better get used to it. What HSBC chief economist Stephen King called the world economy's "Titanic" problem is going to put governments around the world in a massive bind whenever the next recession hits.

Every lever of economic policy is pretty much tapped out, either for economic or political reasons: Finance departments and heads of government seem strongly against fiscal stimulus. Quantitative easing has been fairly unpopular, and its reputation among academics and economists is mixed at best.

In short, the world's economy is an ocean liner, and there aren't enough lifeboats. 

Despite objections, it may well be that negative interest rates are the path of least resistance.  EVIL, NOTHING BUT PURE EVIL!

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