Just two months ago the Federal Reserve (the Fed) hiked the short-term interest rate it controls. The quarter-point increase was the first in nine years after efforts to pump up economic growth by keeping the rate close to zero. Now several members of the Fed are talking about reversing themselves and moving interest rates into negative territory.
It’s not such a far-fetched idea. Sweden, Denmark, Switzerland, Japan and the European Central Bank have introduced negative interest rates. It’s the latest toy in the world of monetary policy, where the economy is seen as an automobile and interest rates are the gas pedal.
When Fed Chair Janet Yellen delivered her semiannual testimony before Congress last week, she said the Fed has not fully researched the issue of charging banks to hold their excess reserves. But the plot took a sinister twist when it was disclosed that the Fed asked banks to consider the impact of negative interest rates during the latest round of bank stress tests.
Under a negative interest rate policy, banks are charged to park their cash with the central bank. The hope is that this will encourage banks to stop hoarding money and instead lend to consumers and businesses to accelerate economic growth.
No one knows if negative interest rates would work in the U.S.; the Fed has never tried them. Fully identifying their impact is very complicated, but we know how the story will play out for the average Joe. If the Fed charges banks for excess deposits, the banks will in turn charge customers for depositing money.
Still further, just because the interest rate is negative does not mean a bank will pay you interest (rather than the other way around) when you pay back a loan. The average customer will not get paid to take out a loan, not now, not ever, never.
Negative interest rates effectively charge the customer for deposits, discourage saving and encourage spending. Forget about saving for retirement and a child’s education; this policy is designed to grow the economy by coercing people to spend. Of course, the customer can at least be held harmless by holding cash and earning a zero percent nominal return.
The Fed has effectively punished the millions of American who rely on their savings to get by. Safe options such as savings accounts, certificates of deposit and treasury bonds offer pitiful returns forcing many people to dig into their principle to make ends meet. Under negative interest rates, the longer funds are on deposit the less money is available for withdrawal as banks charge to hold the money. Also, if people are unable to retire, many will either remain in or re-enter the labor force, thereby competing with younger workers for jobs or risk their savings by putting money in risky investments.
Crazy as it sounds, this may be the new normal. Remember that when the Fed thought they could not cut the interest rate any more, they engaged in quantitative easing: basically creating money out of thin air and releasing it into the economy, mainly by buying bank debt securities.
Bargain-basement interest rates and flooding the system with trillions of dollars in cheap money has produced sharp stock market gains -though even that has ended in recent months – and enabled corporations to buy back their own shares and pursue mergers and acquisitions instead of expanding production and creating jobs. It’s time for the public to ask what we have to show for these aggressive and addictive monetary policies that are a misallocation of resources and contribute to income inequality by shifting wealth to asset owners.
Monetary policy does not make for good presidential debate sound bites, but the time is long overdue for candidates to engage on the issue of federal monetary policy and how it has contributed to income inequality.
originally published: February 20, 2016
