AFCA Think Tank Working Paper by Hubertus Väth
The concept of negative interest rates appears anathema to conventional economic thinking, and it is rarely discussed in economic literature. However, this changed when central banks began cutting their leading interest rates below zero. First in Sweden in 2009 and then in Switzerland, Denmark, the eurozone and Japan. Negative rates became a part of the monetary tool kit. Sub-zero rates soon spooked bond markets as well. For a brief moment in 2019, as US rates rose and even more euro-denominated bonds began to see some positive yields, markets expected a return to normalcy, that is, to positive rates. However, the sudden COVID-19 pandemic ended this trend and even the US, the UK and Singapore are on the brink of joining the negative yield club.
This article analyses negative rates from a European and mainly German perspective and focusses on three central aspects:
1) stiff headwinds for the international profile of the euro,
2) the impact on banks, particularly those with a strong deposit base, and
3) the interaction of rates and government debt.
This article also contrasts the views of central banks and their critics, which range from monetary economists warning of low-interest rate’s potential contractionary effects to followers of Modern Monetary Theory arguing that public debt volume and interest rates are mostly irrelevant.
Meanwhile, negative interest rates have become more common as the traditional arsenals of monetary policy have become depleted. However, the side-effects are considerable and deserve consideration.