Negative interest rate policies are backfiring

An unintended consequence of negative interest rates is to stifle domestic demand as commercial bank profits are squeezed, according to an interesting study—especially since so many central banks are turning to the practice.
   
Negative interest rate policies—where nominal rates are set below zero percent—have  been introduced in Europe and Japan to stimulate flagging economies but new research shows the unconventional monetary strategy may be doing more harm than good.

Recently, several major European banks announced plans to pass on negative interest rates to corporations and wealthy individuals. Since 2012 Japan and six European economies—the Eurozone, Denmark, Hungary, Norway, Sweden and Switzerland—introduced negative interest rates, making it costly for commercial banks to hold their excess reserves with central banks.

Negative interest rates are supposed to stimulate the domestic economy by facilitating an increase in the demand for bank loans. In theory this could increase new capital investment by firms and domestic consumption, via credit creation.

But the research showed bank margins were being squeezed, curbing loan growth and damaging banking profits.

What the researchers say; “This is a good example of unintended consequences. Our study shows negative interest rate policy has backfired, particularly in an environment where banks are already struggling with profitability, slow economic recovery, historically high levels of non-performing loans, and a post banking-crisis deleveraging phase,” said the lead author of the study.

“If bank margins are compressed due to low long-term yields, and if there is limited loan growth, then bank profits will fall accordingly. The decline in profits can erode bank capital bases and hitherto further limit credit growth, thus stifling any positive impact on domestic demand from negative interest rate policy monetary transmission effects,” he said.

The team, which included researchers from the US Treasury and several international universities, identified new evidence that bank margins and profitability fared worse in countries where negative interest rates were adopted than in countries that did not pursue this policy.

The results also suggested that following the introduction of negative interest rates, bank lending was weaker than in countries that did not adopt the policy. This was largely driven by the compressed net interest margin from a long-term low yield.

The researchers said negative interest rates also appear to have cancelled out the stimulus impact of other forms of unconventional monetary policy such as quantitative easing.

So, what? Perhaps all human endeavors are plagued by unintended consequences. But this one could surely have been foreseen.

Nobelist Paul Krugman, along with other noted economists, contends that we are in the age of late-stage capitalism. The problem seems to be that few politicians, central bankers or even academics know with any certainty where we go from here. The future, as the cliché goes, is an unknown land.

However, it will probably not be built on negative interest rates.