With all the talk of negative interest rates, we have to determine why they are considered so important. They are obviously very important to bankers, economists and central bankers. This article is not an attempt to encourage these folks because of the danger of cashless regulations once a negative regime is put into place. But looking into motives becomes quite helpful to see where central banks are going with all this since they do not consult with us. I call the plunge into minor negativity the Office Space scheme. The dangers of too much reliance on negative rates will be shown.

There are three categories of negative rates. As you read articles this breakdown is helpful since the authors don't always make clear which they are speaking to:

1. Minor negative rates on bank reserves that would not cause a run on the banks.

2. Major negative rates on bank reserves that could cause a run on the banks.

3. Negative treasury bond rates that could slow down the economy.

Image Source: Narayana Rao Kocherlakota (served as the 12th president of the Federal Reserve Bank of Minneapolis)

Minor negative rates on reserves , are less than the costs incurred if banks stored their own money. Major negative rates would almost certainly require banks to pass the rates onto retail customer accounts or pull their money out of the central banks.

And even passing costs onto retail customers may not cause bank runs, if the customers perceive the rates are not too deeply negative and if the convenience trumps the negative interest. It is risky to assume these retail versions of negative rates are in the minor category. Maybe, maybe not.

The Fed and central banks are not too worried about the minor rates, which are less a cost to banks than paying the cost of storing money. Stephen Williamson, New Monetarist Fed VP, has said negative rates in Switzerland seem like no big concern. So, these would be the result of central banks charging banks to store money at the central bank.

The concept of negative IOR is no big deal to New Monetarists, but is central to the economic school known as Market Monetarism which wants banks to lend more to each other, avoiding paying negative IOR. As Scott Sumner has said, negative IOR is always expansionary and should be considered. Others think it is ineffective.

But as Williamson hints at, minor negative rates, while technically breaking the zero lower bound, don't really do so because the cost to banks is still less than the cost of storing the money. But going too low in a major way would certainly destroy the zero lower bound causing banks to consider more drastic measures. Remember, I are not talking about the Fed Funds Rate, which has seen real, not nominal negative rates in the past. I are talking about negative interest on reserves (IOR).

So, I am reminded that central banks really only need minor negative rates often times no more than negative point one percent, not major negative rates, in order to alleviate the cost of government debt. If they can collect just a little bit of money, it is way better than paying it out to the banks, because it means a lot of money will be passed on to the treasuries of the nations. Nations will be paid to borrow. So, for example, the Bank of Japan, the BOJ, charges banks a small, minor negative rate on reserves, in order to pass money to the most indebted government in the world, Japan.

Now, if governments and central banks are careful, they could use some of this money to stimulate the economy, as the private sector in Japan appears to be comatose. That is true for Europe as well. In a downturn, it could be true for the United States as well. But the point is, this money from government spending would stimulate the private sector and could be a good thing.

However, if this method of funding government proves to be done irresponsibly, governments could spend too much with the expectation that they could get more from the central banks at a later date. They could spend so much that central banks would be forced to lower negative rates into the major category, where banks would save money pulling the cash out of the central banks and storing it themselves. Or the banks would have to charge customers, creating the risk of bank runs by retail customers.

That could even lead to a cashless society, and bankers like Larry Summers have called for the elimination of big bills, and Buiter has called for the elimination of cash.

So, the question would be, could government be careful about all this? I am reminded of the movie, Office Space, where the desperate costars (who fear being laid off) plan to pilfer just fractions of pennies from Initech, where they worked, into a bank account they controlled. Turns out a decimal point error makes the pilfering far in excess of the fractions of pennies.

I think most central bankers have all seen the film, because they likely want to avoid the error of overshooting to the negative, because they certainly are convinced that going a little negative with IOR is just ok, and will actually help governments. I realize that helping government scenario is not the Market Monetarist goal, because he wants banks to lend money to other banks in a hot potato effect, rather than have them pay the negative IOR to the central banks. Market Monetarists claim to be libertarian. I assume by that they mean they would not want negative IOR to be just a government money collection scheme.

And certainly, the MM guy does not want banks to buy bonds, pushing yield down and prices up. Negative bond yields are a bad idea even if negative IOR is a good idea to them. It would be ok if the bond yields stayed positive, but Econbrowser says banks could trade them with each other, pushing the yields down to negative. Bad idea.

So, getting banks to behave the way that the central banker wants them to behave in a negative IOR environment could become an issue.

It is clear that former Fed president, Narayana Kocherlakota, wants government to spend a lot of money through the use of negative nominal rates on Fed funds rate. This is different than negative IOR. He realizes, as I have noted in past articles, that there is massive demand for treasury bonds, and that more could be issued than are issued now. Projects could be financed by this issuance. Only problem is we aren't quite negative here in the USA, yet. Negative bonds could be a bad idea.

That is why Kocherlakota wants more government spending, to force the creation of more treasury bonds. That would help drive long bond yields up, which would be more normal, but at what cost? There could be unintended consequences. He switched from being a libertarian to some Keynesian and Monetarist ideals, especially with regard to fiscal spending. He and his Freshwater school was embarrassed when inflation did not go crazy as QE was implemented.

But Kocherlakota and some central bankers seem to want the big money paying government. It would seem that negative IOR is not enough for them. They are way more ambitious than that. Negative IOR would help but would not be a massive windfall for governments, but negative bond rates would be a massive windfall.

So, it makes more sense to me to ban long bonds for use as collateral in the derivatives markets, since that use creates a false demand for the bonds, than to just spend massive money in order to create more bonds for more derivatives deals. It looks like low long bond yields no longer predict economic downturn but just bond scarcity, though some are more cautious about that view.

Kocherlakota could be right (although I hope not), that growth must be molded by massive government stimulus since private industry has become too cautious. He may be right that preventing deflation in the world requires massive government spending. He may be right that more treasury bonds would force yields up, though I have some doubts with the collateral demand issue still in play.

But once you start down the road of negative bond rates, where do you stop? How low can you go? Apparently some bankers are prepared to go very low. That is when this experiment becomes seriously risky.

So, the only conclusion here is that risk exists from doing nothing and risk exists in doing massive stimulus by government and there is risk in between, like with Negative IOR. Kocherlakota wants big stimulus, which seemed to work in WW2, but the hangover would be worse now. The US was stronger after WW2 and was able to shake off the hangover quickly. Williamson, who claims that Freshwater/Saltwater means little today,seems happy with a little deflation and a little negativity of rates in Europe, and was ok with QE.

If there is a huge economic downturn, not getting it right could be hazardous to all of us.

Perhaps something else should be tried, since just protecting banks and the wealthiest has been the only solution and has never really worked that well. At least that was the view of Will Rogers:

"See where Congress passed a two Billion dollar bill to relieve bankers' mistakes. You can always count on us helping those who have lost part of their fortune, but our whole history records nary a case where the loan was for the man who had absolutely nothing." DT #1715, Jan. 22, 1932

And the loans from Congress end up being forgiven anyway.That is doubly painful for main street.

It appears that most of the economists, ie., the New Monetarists who have moved past the Freshwater views, the New Keynesians and the Market Monetarists, are all for some sort of negative nominal rates placed on something. They all have their reasons, but they all play into this potentially dangerous trend, which could result in efforts toward a cashless society, that none of them seem to see as being very dangerous at all.