Social Europe

politics, economy and employment & labour

  • Themes
    • Global cities
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter
  • Membership

The False Promise Of Negative Interest Rates

Robert Skidelsky 31st May 2016

Robert Skidelsky

Robert Skidelsky

As a biographer and aficionado of John Maynard Keynes, I am sometimes asked: “What would Keynes think about negative interest rates?”

It’s a good question, one that recalls a passage in Keynes’s General Theory in which he notes that if the government can’t think of anything more sensible to do to cure unemployment (say, building houses), burying bottles filled with bank notes and digging them up again would be better than nothing. He probably would have said the same about negative interest rates: a desperate measure by governments that can think of nothing else to do.

Negative interest rates are simply the latest fruitless effort since the 2008 global financial crisis to revive economies by monetary measures. When cutting interest rates to historically low levels failed to revive growth, central banks took to so-called quantitative easing: injecting liquidity into economies by buying long-term government and other bonds. It did some good, but mostly the sellers sat on the cash instead of spending or investing it.

Enter negative interest-rate policy. The central banks of Denmark, Sweden, Switzerland, Japan, and the eurozone have all indulged. The US Federal Reserve and the Bank of England are being tempted.

“Negative interest rate” is a phrase seemingly designed to confuse all but the experts. Instead of paying interest on commercial banks’ “excess” reserves held by the central bank, the central bank taxes these deposits. The idea is to impel the banks to reduce their unspent balances and increase their lending or investments. In the case of the European Central Bank, there is a technical reason: to increase the supply of high-class bonds for President Mario Draghi’s ongoing program of quantitative easing.

The policy is supposed to work by aligning the market rate of interest with the expected rate of profit, an idea derived from the Swedish economist Knut Wicksell. The problem is that whereas until now it had been believed that nominal interest rates cannot fall below zero, an investor’s expected rate of return on a new investment may easily fall to zero or lower when aggregate demand is depressed.

Negative interest rates are the latest attempt to overcome the mismatch of incentives for lenders and borrowers. Making it more costly for commercial banks to park their money with the central bank should lower the cost of commercial loans. The calculation is that it will make more sense for a commercial bank to put money into circulation, whether by making loans or buying government and other securities, than to pay the central bank for holding that money.

But, as the World Bank has pointed out, negative rates can have undesirable effects. They can erode bank profitability by narrowing interest-rate margins. They can also encourage banks to take excessive risks, leading to asset bubbles. Lower interest rates on deposits may cause large sections of the economy to become cash-based, while pension and insurance companies may struggle to meet long-term liabilities at a fixed nominal rate.

But, quite apart from these problems, the real case against negative interest rates is the folly of relying on monetary policy alone to rescue economies from depressed conditions. Keynes put it in a nutshell: “If we are tempted to assert that money is the drink which stimulates the system into activity, we must remind ourselves that there may be several slips between the cup and the drink.” His list of “slips” is well worth recalling:

“For whilst an increase in the quantity of money may be expected…to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money; and whilst a decline in the rate of interest may be expected…to increase the volume of investment, this will not happen if [profit expectations] are falling faster than the rate of interest; and whilst an increase in the volume of investment may be expected…to increase employment, this may not happen if the propensity to consume is falling off.”

Quite so. Economists are now busy devising new feats of monetary wizardry for when the latest policy fails: taxing cash holdings, or even abolishing cash altogether; or, at the other extreme, showering the population with “helicopter drops” of freshly printed money.

The truth, however, is that the only way to ensure that “new money” is put into circulation is to have the government spend it. The government would borrow the money directly from the central bank and use it to build houses, renew transport systems, invest in energy-saving technologies, and so forth.

Sadly, any such monetary financing of public deficits is for the moment taboo. It is contrary to European Union regulations – and is opposed by all who regard post-crash governments’ fiscal difficulties as an opportunity to shrink the role of the state.

But if it is at all true that we are entering a period of “secular stagnation” and growing joblessness, as Larry Summers and others have argued, a larger investment role for the state is inescapable. Events following the crash of 2008 clearly show that monetary policy on its own cannot achieve a level of economic activity close to its potential. The state must be involved.

Whether the capital spending appears on the books of the central government or on the balance sheet of an independent investment bank (as I would prefer) is secondary. Negative interest rates are simply a distraction from a deeper analysis of what went wrong – and what continues to go wrong.

© Project Syndicate

Robert Skidelsky

Robert Skidelsky, professor emeritus of political economy at Warwick University and a fellow of the British Academy in history and economics, is the author of a three-volume biography of John Maynard Keynes and a member of the British House of Lords.

You are here: Home / Economy / The False Promise Of Negative Interest Rates

Most Popular Posts

Belarus,Lithuania A tale of two countries: Belarus and LithuaniaThorvaldur Gylfason and Eduard Hochreiter
dissent,social critique,identity,politics,gender Delegitimising social critique and dissent on the leftEszter Kováts
retirement,Finland,ageing,pension,reform Late retirement: possible for many, not for allKati Kuitto
Credit Suisse,CS,UBS,regulation The failure of Credit Suisse—not just a one-offPeter Bofinger
Europe,transition,climate For a just and democratic climate transitionJulia Cagé, Lucas Chancel, Anne-Laure Delatte and 8 more

Most Recent Posts

Barcelona,feminist,feminism Barcelona: a feminist municipalism now at riskLaura Pérez Castaño
Spain,elections,Sánchez Is Spain on the right track?Bettina Luise Rürup
CBI,Confederation of British Industry,harassment Crisis at Britain’s CBI holds lessons for othersMarianna Fotaki
central and eastern Europe,CEE,renewable Central and eastern Europe: a renewable-energy win-winPaweł Czyżak
Cape Town,inequality Tackling inequality in the city—Cape TownWarren Smit

Other Social Europe Publications

Bildschirmfoto 2023 05 08 um 21.36.25 scaled 1 RE No. 13: Failed Market Approaches to Long-Term Care
front cover Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship
Women Corona e1631700896969 500 Women and the coronavirus crisis

Foundation for European Progressive Studies Advertisement

The spring issue of the Progressive Post magazine from FEPS is out!

The Special Coverage of this new edition is dedicated to Feminist Foreign Policy, to try to gauge its potential but also the risk that it could be perceived as another attempt by the west to impose its vision on the global south.

In this issue, we also look at the human cost of the war in Ukraine, analyse the increasing connection between the centre right and the far right, and explore the difficulties, particularly for women, of finding a good work-life balance and living good working lives.


DOWNLOAD HERE

Hans Böckler Stiftung Advertisement

The macroeconomic effects of re-applying the EU fiscal rules

Against the background of the European Commission's reform plans for the Stability and Growth Pact (SGP), this policy brief uses the macroeconometric multi-country model NiGEM to simulate the macroeconomic implications of the most relevant reform options from 2024 onwards. Next to a return to the existing and unreformed rules, the most prominent options include an expenditure rule linked to a debt anchor.

Our results for the euro area and its four biggest economies—France, Italy, Germany and Spain—indicate that returning to the rules of the SGP would lead to severe cuts in public spending, particularly if the SGP rules were interpreted as in the past. A more flexible interpretation would only somewhat ease the fiscal-adjustment burden. An expenditure rule along the lines of the European Fiscal Board would, however, not necessarily alleviate that burden in and of itself.

Our simulations show great care must be taken to specify the expenditure rule, such that fiscal consolidation is achieved in a growth-friendly way. Raising the debt ceiling to 90 per cent of gross domestic product and applying less demanding fiscal adjustments, as proposed by the IMK, would go a long way.


DOWNLOAD HERE

ETUI advertisement

The four transitions and the missing one

Europe is at a crossroads, painfully navigating four transitions (green, digital, economic and geopolitical) at once but missing the transformative and ambitious social transition it needs. In other words, if the EU is to withstand the storm, we do not have the luxury of abstaining from reflecting on its social foundations, of which intermittent democratic discontent is only one expression. It is against this background that the ETUI/ETUC publishes its annual flagship publication Benchmarking Working Europe 2023, with the support of more than 70 graphs and a special contribution from two guest editors, Professors Kalypso Nikolaidïs and Albena Azmanova.


DOWNLOAD HERE

Eurofound advertisement

Unaffordable and inadequate housing in Europe

Unaffordable housing is a matter of great concern in the European Union. It leads to homelessness, housing insecurity, financial strain and inadequate housing. It also prevents young people from leaving their family home. These problems affect people’s health and wellbeing, embody unequal living conditions and opportunities, and result in healthcare costs, reduced productivity and environmental damage.

This new report maps housing problems in the EU and the policies that address them, drawing on Eurofound’s Living, working and Covid-19 e-survey, EU Statistics on Income and Living Conditions and input from the Network of Eurofound Correspondents.


DOWNLOAD HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube