FEB. 12, 2016 — Have we got a strange deal for you, Federal Reserve chief Janet Yellen said — hypothetically — to America’s banks: Instead of paying interest on deposits you store with us, maybe we consider charging you a fee.
And so an unnatural, break-glass-in-case-of-emergency concept got a surprise hearing Thursday on Capitol Hill: negative interest rates.
With the U.S. economy stuck in weak growth mode but buffeted on many sides by real turmoil — China struggling, oil plummeting, the Dow freaking — Yellen was asked about the idea of the Fed going negative on its benchmark interest rate. The theory: Because even near-zero interest rates in the U.S. haven’t enticed enough businesses to borrow and expand, the Fed would prod banks into lending by penalizing them for sitting on their money.
Yellen’s cautious answer suggests the chances of doing so are remote: U.S. prospects for growth would really have to sink. But the idea is definitely not out of the realm of the possible. “I wouldn’t take those off the table, but we would have work to do to judge whether they would be workable here,” Yellen told the Senate Banking Committee.
She talked about whether the idea was feasible “here” because central banks in Europe already are using negative rates, and Japan just introduced them. The mechanics of what Europe is doing seem to be causing no serious glitches, but we’ve also seen that negative rates don’t magically unlock growth. And no one can anticipate the long-term implications.
More to the point, whatever’s going on in Sweden, Japan or the European bond market is nothing compared to introducing negative rates in the largest, most sophisticated economy in the world. How would the markets react to such an extreme measure? Would the Fed’s credibility take a hit? And once a central bank starts offering negative rates, where does it set limits for its unorthodox behavior?
In other words, this is radical, unwelcome stuff that adds instability to a fragile world. “I think it’s playing with fire,” Jack Ablin, chief investment officer at BMO Private Bank, told us. “Once you start introducing negative interest rates I think it’s really a whole new world and I can’t fathom it.”
In Japan and Europe, trillions of dollars of government debt offer yields below zero. When the Financial Times tried to explain why an investor needing to park money someplace would hold a bond that guaranteed a loss if held to maturity, it sort of shrugged and settled on the “greater fool” theory of investing: A trader can still make a profit by selling these terrible bonds to someone else who thinks central banks will keep pushing further below zero, it said.
Does that sound like an ingredient in anyone’s recipe for recovery?
We heave a small sigh of “if only” about negative rates because it signals that the Fed is running out of other options to provoke growth. This could have played out differently. In the years after the Great Recession that ended in June 2009, the Fed held its benchmark rate near zero as the economy recovered, unemployment declined and the markets regained their luster. The Fed finally lifted rates above zero in December, but it was late. In March, we wrote that it was time for the Fed to raise rates in order to make a statement that the crisis years were behind us, and to create breathing room in case trouble returned and the central bank needed to step in and ratchet rates back down. “You can’t drop rates if they’re bumping on zero,” we warned.
OK, so it turns out maybe you can drop rates below zero. But it’s risky. Markets were tanking Thursday on continued fears about China’s growth and Europe’s banks. Baked into those concerns is the recognition that central banks around the world are running out of tricks.
There is another approach, and it has nothing to do with the Fed’s control of interest rates. If the crux of the problem is firing up the American economy, let’s see Washington get past its interminable gridlock and find ways to help American business grow. Doing something positive is always better than doing something negative.
