E Clearing Up Negative Interest Rate Confusion. Kocherlakota Weighs In

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).

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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