Negative Rates Are Creating a Tax, Not a Stimulus

In 2016, we have seen the Bank of Japan (BoJ) surprise the markets with a move into negative rates for commercial deposits held at the central bank.  Then, we saw the European Central Bank (ECB) expand its negative rate policy deeper into the red.  Both moves resulted in an instantaneous weakness of their currency that was then quickly reversed, setting off a sustained round of strength – which was clearly not the intent of either the BoJ or ECB.


Negative rates euro


Negative rates Yen


Negative Rates Should Encourage Credit Expansion and Spending

Negative rates from a central bank will only work as a stimulus if they encourage banks to extend more credit so consumers and businesses can expand spending.  There are two reasons this does not happen.

First, commercial banks are highly unlikely to be able to pass on the negative rates they pay the central bank to their retail and business clients.  Indeed, some clients may choose physical gold or even large-size cash notes under the mattress to avoid paying the penalty for holding deposits aimed at liquidity preservation.  And, worse, banks cannot lend more anyway.  In Europe and Japan, banks are already bumping up against their regulatory capital requirements.  Thus, the extra tax works to reduce profits and make building-up capital all that more difficult.

Hence, negative rate policies from a central bank may be more correctly interpreted as a tax increase and a tightening of policy.  This interpretation helps to explain why the exchange rate has appreciated in the aftermath of the introduction of more negative rate policies.  As countries balance the adverse impact on the banking system from negative rates, we expect they will choose alternative policies which might be more effective.

Neative rates graph 3

Bluford (Blu) Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. He is responsible for leading economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact. Prior to joining CME Group, Putnam gained more than 35 years of experience in the financial services industry with concentrations in central banking, investment research and portfolio management. He has authored five books on international finance.

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