Negative interest rates hit the big time

Reuters

Article Highlights

  • How negative can interest rates be? Could it be negative 2% or 3% or more?

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  • For central bank policy rates, there is a zero bound only if they all think there is a zero bound

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The European Central Bank is discussing whether it should for first time set negative interest rates for banks’ deposits with it, and may well do so at its meeting on June 5. The press is discussing the ECB’s discussions. This is a highly interesting development financially, but also intellectually. (To be clear, this means negative nominal interest rates, not just negative real rates which result from inflation being higher than positive nominal interest rates.)

Economists often used to proclaim that there was a “zero bound” to interest rates—that nominal interest rates could be positive or even zero, but never negative. It wasn’t true, but that didn’t stop them from thinking it. Indeed, for central bank policy rates, there is a zero bound only if they all think there is a zero bound.

Negative interest rates are perfectly possible: they have actually been used by smaller central banks—the Swiss as early as the 1970s, and the Swedish and Danish central banks recently. But the ECB would mark the first use by a big time, principal central bank. The German Bundesbank has already announced it agreement with the possibility.

Since this all makes it even more obvious than before that interest rates can be negative, at least we should not have to hear about the “zero bound” any longer. But an interesting question does remain: how negative can interest rates be? A number like negative ½% is one thing—could it be negative 2% or 3% or more? This question awaits more experience.

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Alex J.
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