RUTH SUNDERLAND: Negative interest rates do harm

0
11
Thrifty: In practice, negative rates have been around for a while. In real terms, nest-eggs have shrunk


RUTH SUNDERLAND: Negative interest rates are an insidious way of making savers finance Government’s debt pile, but economies that victimise the thrifty seldom thrive in the long run

Savers, collectively, are losing billions of pounds by stealth in the Covid-19 pandemic, just as they have lost out since the financial crisis. 

Now, with the threat of negative interest rates hanging over the UK economy, their plight is only going to get worse. 

Andrew Bailey, the new governor of the Bank of England, has indicated he might cut interest rates to below zero from their current 0.1 per cent. In practice, negative rates have been around for a while. In real terms, nest-eggs have shrunk. 

Thrifty: In practice, negative rates have been around for a while. In real terms, nest-eggs have shrunk

But for the Bank of England to embrace such an extreme measure as official policy would still be a big deal. We are in desperate times and must consider desperate measures, but negative rates have harmful effects beyond the obvious hit on savers – and are not guaranteed to work. 

Japan and the Eurozone have experimented with negative rates and those economies are not exactly booming – though things could have been worse if they hadn’t. Like Quantitative Easing, negative rates are known to economists as an ‘unconventional policy tool,’ or to non-economists as funny money. 

Government borrowing has mushroomed due to Covid-19, and negative interest rates might seem appealing. The concept, though, takes us into Alice in Wonderland territory. 

The normal tenets of economics, where interest rates are positive, hold that lenders should be compensated for the risk of nonpayment. Savers should receive a return for, in effect, loaning money to the bank, and borrowers should pay for the privilege of using someone else’s cash. This is all thrown out of the window with negative rates. 

It is unlikely that British mortgage borrowers will receive interest or that savers will have to pay their building society. 

What happens under a negative rate policy is that banks are charged interest on excess cash over and above the capital they are required to hold, so they are incentivised to lend it out instead, which should in theory boost the economy.

But negative rates harm the profitability of the banks, because they reduce the margin they normally make by charging borrowers more than they pay to savers. 

A weakened banking system is the last thing we need. The banks are well capitalised but one wonders how long that will last. When rates are low or negative, savers and investors move into other assets. 

Since the financial crisis, there have been strong rises – until recently – in property and shares. This has fuelled inequality. The asset-rich have got richer and, since the wealthy tend to be older, the generational divide has widened. Conversely, negative rates can spur people to keep cash under the mattress, which brings its own risks. 

Negative rates invert the usual order. They look bonkers, and that in itself makes people confused and less confident. 

If they come, they will be billed as an emergency measure – just as QE money printing was more than ten years ago. As with QE, which now adds up to £645billion after a recent round, the danger is that it becomes a long-standing fixture. 

Low interest rates over the past decade have incentivised borrowing and discouraged saving. One reason our economy has unravelled with such speed is that too many households and firms have gone into this crisis in a highly vulnerable state, with heavy debts and no buffer of savings. 

Negative rates are an insidious way of making savers finance the Government’s debt pile. But economies that victimise the thrifty seldom thrive in the long run.

Advertisement





Source link