President Donald Trump, who last week urged the Federal Reserve to cut interest rates “to zero or less,” had better hope he doesn’t get what he asked for.
There’s a reason, after all, why rates are negative in Japan and much of Europe but positive in the United States: Their economies are weaker than ours.
The Fed, for good reason, has treated negative interest rates as a last-ditch policy move, something to be tried only in dire circumstances. In all likelihood, the U.S. will get negative rates only if we’re in a deep recession and policymakers see no other way out.
“Negative rates are not something you see in a good or strong economy,” says Brian Rehling, co-head of global fixed income strategy at Wells Fargo Investment Institute. “I think the jury’s out whether they really provide any benefit.”
The European Central Bank moved its short-term deposit rate into negative territory five years ago, and it’s still waiting for a pickup in business and consumer spending. Last week, the European Central Bank lowered its rate a tenth of a point to minus 0.5%.
Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, figures the ECB, along with central banks in Japan and Switzerland, are probably approaching the limit of negative rates.
“You can always get a zero return on paper currency, so that limits how low rates can go,” Gagnon said. “We’re never going to see minus 5 percent, and probably not minus 2 or even minus 1.”
Ordinary savers, especially retirees who don’t want to take risks with their money, suffer when rates stay unusually low. So do pension funds, whose promises to pay future benefits become more expensive in a negative-rate world.
Banks themselves take a hit when they must pay to hold reserves at the central bank. Most are unwilling, at least at first, to charge their own depositors for keeping money in the bank, so their profits are squeezed.
Negative rates are designed to stimulate lending, but evidence is mixed on whether that happens. “There is research that says the effectiveness diminishes if you go below zero,” Gagnon says. “The negative rates become a tax on banks, which then are less profitable and less willing and able to lend.”
The Federal Reserve, after watching the Europeans and Japanese struggle with negative rates, apparently doesn’t want to join the experiment. “The Fed will do just about anything before going to negative rates,” Rehling says.
The Fed is widely expected to cut interest rates by a quarter of a point this week, putting its target rate at between 1.75 percent and 2 percent. In the event of a recession, its first policy response would be to take that to zero, as it did in 2008.
It also could resume purchases of long-term bonds and use forward guidance to indicate that zero rates would stick around for a long time. If that proved inadequate, Gagnon could see the U.S. reluctantly adopting negative rates.
Trump, who once described himself as the “king of debt,” sees negative rates as an opportunity to refinance the government’s massive obligations on favorable terms. The rest of us, though, should view them as more threat than opportunity.
In normal times, lenders earn interest and borrowers pay it. When that relationship is reversed, something is very wrong with the economy.