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Op-Ed

Negative interest rates are counterproductive

Robert Pozen

Central bankers in several countries have entered the “neverland” of negative interest rates in an effort to promote economic growth and boost price inflation to 2 percent per year. These countries include Denmark, Switzerland, Sweden and Japan as well as the European Central Bank.

These central bankers apparently believe that negative interest rates will motivate consumers to save less and spend more. In turn, higher consumer spending will allegedly induce companies to invest in new products and facilities — thus, promoting economic growth and raising consumer prices.

However, negative interest rates have so far not produced the desired behavioral changes of consumers or companies. While there are many possible explanations for these non-results, I believe that many central bankers have underestimated the adverse psychological and political effects of their unusual monetary policies.

Despite negative interest rates on deposits in many European banks, consumers have not ramped up their spending, as many economists would predict. In theory, when the returns on savings are zero or less, consumers should be spurred to save less and spend more. In addition, since negative interest rates are used by central banks to boost the rate of price inflation, consumers should theoretically spend more now before prices rise.

In fact, consumers have recently increased their savings and reduced their debts in Denmark, Sweden, and Switzerland. In Japan, consumers are also saving more. More generally, this summer, consumer savings hit their highest levels since 1995, when the Organization for Economic Cooperation and Development started collecting data on savings in advanced industrialized countries.

There are many possible explanations. Older workers, faced with very low investment returns, may have decided to save more for retirement. Younger workers without a big nest egg may be building up their own liquidity in fear of another financial crisis. Most importantly, some consumers have interpreted negative interest rates as a sign that their central bank is panicking, so they need to hunker down — and perhaps buy gold.

Thus, ironically, negative interest rates may be undermining the confidence of consumers in the economy — which is necessary for them to borrow and spend. For the year from Q2 2015 thru Q1 2016 (before the June vote for Brexit), Nielsen’s surveys show that consumer confidence has been generally declining in all four countries with negative interest rates.

Give the weakness of consumer demand, companies and banks continue to let cash pile up on their balance sheets. In March of 2016, the cash held by 75 of the biggest non-financial companies in Europe had increased almost 40 percent over the last 6 years. In the European Union, the vast majority of banks see no material impact on lending volumes as a result of negative interest rates, according to Deutsche Bank.

Some executives are concerned about the slowdown in China and emerging markets. Other executives have been taken aback by the strident anti-business rhetoric prevalent in political debates. In addition, with interest rates so low, many company executives feel pressured to increase cash dividends to their shareholders.

But research by MIT Professor Kothari and his colleagues demonstrates that interest rate cuts are generally a weak tool to promote business spending. Based on 60 years of data, he concluded that “moving the interest rate by one or two per cent does not generate a change in the investment behavior on the part of corporations.” Given these findings, central bankers should not expect lowering interest rates by one-quarter or one-half of 1 percent to trigger a boom in corporate borrowing or investing.

Rather, company executives tend to respond to a positive profit outlook and a stable environment for growth, according to Kothari. For example, the study found that a $1 increase in profits led to a 25 percent increase in investment the following quarter, and nearly $1 over the next five quarters.

In short, we have reached beyond the effective limits of interest rate cuts to promote economic growth. That now requires other governmental policies such as significant infrastructure investments and targeted tax incentives. But radical monetary measures like negative interest rates have taken the political heat off legislators to adopt needed fiscal policies.

Author

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Robert Pozen

Chairman, MFS Investment Management Former Member, President's Committee to Strengthen Social Security

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