Charts of the week – Negative interest-rate policy (NIRP)

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Exhibit 1: For many of the world’s major central banks, policy rates remain ultra-low and indeed a number of them have adopted  a negative interest-rate policy. This graph shows changes in official rates of the Swiss National Bank (SNB), US Federal Reserve, European Central Bank (ECB) and Bank of England (BOE) for the period between December 2014 and March 2016.

leading central bank ratesSource: Bloomberg, April 2016

Exhibit 2: In January 2016, the Bank of Japan (BoJ) introduced a negative interest rate as part of its monetary policy. One consequence has been a sharp fall in the yields of Japanese government debt instruments as investors move into longer-dated assets in search of returns.

Japan government bond yields

Source: Bank of Japan data; April 2016

Exhibit 3: Japan leads the world in terms of the amount of outstanding sovereign debt yielding less zero per cent. This state of affairs reflects the scale of the BoJ’s quantitative easing (JPY 80 trillion/year or about USD 728 billion/year) most of which has been purchases of Japanese government debt. negative rate bonds

The BoJ is now buying almost 90% of the net Japanese government debt issuance and owns over 30% of outstanding debt. As such, the BoJ faces potential capacity constraints. However, the introduction of negative interest rates provides a means of delivering monetary easing. That said, it is questionable how stimulative negative interest rates will be in a savings-orientated economy such as Japan’s (as negative interest rates transfer wealth from thrifty savers to the government whose debt servicing bill is reduced).

What will the BoJ do after introducing a negative interest-rate policy?

There is speculation that the BoJ – whose introduction of negative interest rates has so far not had the desired results (contrary to what might have been expected, the Japanese yen has rallied and the Nikkei equity index has fallen since 29 January) – may soon undertake a ‘helicopter drop’ of the type envisaged by Milton Friedman in 1969:

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” 

(Milton Friedman, “The Optimum Quantity of Money,” 1969)

Such speculation does not suggest that the BoJ literally hires helicopters to scatter banknotes over Japan. What a ‘helicopter drop’ could mean is some sort of central bank-financed fiscal stimulus where, for example, each citizen’s bank account would be credited with, say, JPY 10,000.

If this sounds far-fetched, think again. In March 1999, Japan undertook fiscal stimulus of this type – over 30 million shopping vouchers, each worth JPY 20 000, were distributed to the population. The results were not particularly convincing – almost half the population did not use the vouchers before their six-month expiry date. Subsequent studies suggested that this and a second such programme had little impact on consumption patterns.

Exhibit 4: Negative rates and demand for large denomination bank notes in Switzerland

Statistics published by the Swiss National Bank this year suggest that savers may be hoarding large-denomination banknotes as they seek to avoid negative interest rates on bank deposits.

negative rates

Source: Swiss National Bank data, April 2016

In September 2015, the Bank of England’s chief economist speculated on the possibility that cash would have to be replaced by electronic money in order for central bank negative interest-rate policy to be effective. Kenneth Rogoff (professor of economics at Harvard), wrote an article in 2014 entitled “Paper money is unfit for a world of high crime and low inflation in which he argued that phasing out physical currency would “eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis.” William Buiter, a former UK Monetary Policy Committee member, has also argued that central banks need creative ways to circumvent the zero bound on interest rates.

Demand for new banknotes and coins has, in anycase, been falling for some years in many developed countries. Some central banks have also implemented policies to reduce the number of large denomination bank notes in circulation, taking into account concerns that these banknotes could facilitate illicit activities. The  US Federal Reserve has abolished the 500 US dollar banknote, the ECB is discontinuing production and issuance of EUR 500 banknotes while Singapore is phasing out the 10,000 Singapore dollar banknote. Nordic countries are reckoned to be moving toward cashless societies, perhaps the most extreme example being Denmark where not only will the Danish national bank print no new banknotes after the end of 2016 but businesses and restaurants will soon no longer be obliged to accept payment in cash.

Meanwhile, there are signs that negative interest rates are beginning to pose problems for some institutional investors. The head of France’s largest public pension fund has warned that many retirement funds will face major difficulties if the ECB’s low interest-rate policy continues. This was followed by a warning from the head of the German financial market regulator that some pension funds may be forced to cut benefits to retirees.

ECB President Mario Draghi has acknowledged the problem, but insisted that higher growth and higher inflation are the prerequisite for higher interest rates.

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