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A thread on why @bankofengland moving to negative interest rates could do more harm than good, based on my latest @OMFIF piece & with links to further research: https://www.omfif.org/2020/05/uk-negative-rates-could-do-more-harm-than-good/
The underlying theory behind negative rates is to disincentivise banks from depositing money at the central bank, in order to boost lending, discourage saving & encourage spending, in turn boost aggregate demand & raise GDP growth 2/n
Whether they work in practice depends on the transmission mechanism: whether the direct impact on banks trickles down to their clients. In today's #Covid19 crisis environment, politically hard for banks to pass on negative rates to depositors 3/n
Another channel through which -ve rates work is by weakening the exchange rate, as foreign depositors prefer to take money out instead of paying to keep it in, reducing demand for the currency. This can raise export competitiveness & boost trade's contribution to GDP. BUT 4/n
Amid rising protectionism, #Covid19-related risks to physical cross-border flows & broken supply chains, a weaker currency could have limited value. Plus weaker currency means more costly inputs which (at least in short term) raises costs to households & businesses 5/n
Still, suppose -ve rates work to boost demand through effects on consumption & trade. This may alleviate some pressure but won't be a game changer in an economy primarily suffering from a supply-side shock, as is the case now. What you need instead is targeted fiscal support 6/n
Also qs on cause & effect, h/t @sobel_mark: we know mon policy not v effective at ZLB. -ve rates arise in context of ↓inflation & ↓productivity growth. If -ve rates don't work is it because the conditions under which they emerge preclude them from working? 7/n
Evidence from countries that have tried -ve rates is weak, e.g. see here: https://www.ecb.europa.eu/pub/economic-bulletin/articles/2020/html/ecb.ebart202003_02~4768be84e7.en.html#toc1 & here: https://www.nber.org/papers/w25416 8/n
Bigger risk with -ve rates is not that they don't work but that they bring more harm than good. The 'reversal rate' after which cuts harm savers more than they benefit borrowers is v hard to estimate, but the lower the rates the closer it is. @bankofengland rate already 0.1% 9/n
A 2nd worry is financial stability.If -ve rates come w/ economic & policy uncertainty when there's few productive investments, savers may be pushed to more risky assets, artificially raising prices & potentially creating bubbles. Thankfully there's macropru to deal with that 10/n
As per our @OMFIF #GPI2019 survey of central banks, sovereign funds & public pension funds, low yields on traditional assets are pushing even these conservative reserves managers increase their risk budgets & diversify into higher-yielding assets https://www.omfif.org/omfif-reports/gpi-2019-special-report-asset-allocation-survey/ 11/n
A 3rd worry is damage on bank profits at time of crisis-related defaults (again cause/effect issue). One advantage of UK econ crisis response has been coordination bw @hmtreasury & @bankofengland - measures to support banks could help cushion -ve impact of -ve rates 12/n
Finally, communication is key (& takes time). Moving to -ve rates risks signalling that we are really entering troubled waters, which could lead to people saving even more - the opposite of the intended effect 13/n
If you're interested in this topic some good further reading is here by @krogoff & @BrookingsInst Bernanke: https://www.project-syndicate.org/commentary/advanced-economies-need-deeply-negative-interest-rates-by-kenneth-rogoff-2020-05 https://www.brookings.edu/blog/ben-bernanke/2020/01/04/the-new-tools-of-monetary-policy/ again h/t @sobel_mark END THREAD
