E Negative Interest Rates Make Sense To Bond Investors, But Do Not Always Boost The Economy

“Our market-based estimates indicate that, when the BOJ announced its plan to move to negative policy rates, inflation expectations actually declined and then continued to trend downward afterward. Therefore, Japan’s case is an extreme but potentially informative example illustrating the challenges associated with raising well-anchored inflation expectations through negative monetary policy rates.” (FRBSF Economic Letter, August 26, 2019)

Negative interest rates may make for a difficult or unusual for monetary policy, but from a bond investor perspective, they can make sense, even if intuitively it is a bit hard to grasp.

Many central banks were forced to set their policy rates close to or below zero following the major global financial meltdown in 2008-09. 

As the Federal Reserve Bank of San Francisco recently observed, Denmark’s central bank policy rates fell below zero in July 2012, followed after by a number of other central banks, including the European Central Bank, the Swedish Riksbank, and the Swiss National Bank.

Japan is an interesting case to consider, since it has had an extended experience with ultra low policy rates after allowing its leading policy rate to fall below zero on January 29, 2016. Japan has been battling with very low inflation since the mid-1990s, and its policy rate and other short-term interest rates have been close to zero for much of that time.

Japan’s experience may also provide some useful evidence relating to whether negative policy rates are effective in terms of a central bank supporting a struggling economy.

As it turns out, inflationary expectations are the key to understanding the efficacy of low or negative interest rates in achieving central bank objectives. 

When the Bank of Japan announced its plan to move to negative policy rates in 2016, as one of the following charts illustrate, inflation expectations fell instead of increasing as the BOJ hoped.

Although the decline in inflationary expectations in Japan may not have been triggered by the BOJ’s negative rate policy, nonetheless it still underscores that considerable uncertainty surrounds the effectiveness of using negative interest rates as a tool of economic expansion when inflation expectations are very low.

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Edward Simon 6 months ago Member's comment

Well looks like we are about to see how the Fed can use negative rates effectively and fairly. As for monetary policy being managed by technocrats and not governments, read "politicians", that ability seems to be one that is being tested on a more frequent basis these days.