Rigorous historian though he was, negative interest rates were not something in Shakespeare’s ken.
"As investors (including banks) search for yield, the bidding for higher yield assets becomes more intense - meaning riskier loans are made at prices not reflecting the chance of loss.”
According to John Hawkins, assistant professor at the University of Canberra, negative rates are extremely rare.
“Even rates as low as 1 per cent are historically unusual,” he wrote in The Conversation. “In his epic study of interest rates, A History of Interest Rates (1963), author Sidney Homer suggests rates lower than 3 per cent were virtually unknown in ancient Mesopotamia, Greece or Rome. Or in medieval and renaissance Europe.”
Negative interest rates do have a Through the Looking Glass feel but in theory the concept is not difficult: when you lend someone money, typically you expect more money when the loan is repaid - the principal plus the interest. The interest covers the risk.
When we make a deposit, we are lending money to a bank. So a negative rate means the bank actually pays us back less than we deposited. Not a great outcome - but that’s the intention: deter those with capital from simply depositing it and instead encourage them to invest on the hope of a better return.
That’s the theory. But there are myriad complexities, not least of which is the established body of economic rules begin to break down when interest rates are so low for so long.
For example, John Taylor, creator of one of the most widely used central banking dicta, the Taylor Rule, concedes the rule needs a rethink as global rates approach their “zero-bound”.
Speaking on the sidelines of the recent central banker gabfest in Jackson Hole in the US, Taylor said his rule - which sets short-term interest rates against an inflation target and full employment - was still relevant but near zero interest rates had wide implications for capital flows, currency levels and cross-border anomalies.
There are actually physical challenges too with negative rates. Few financial institution technology platforms are designed to accept negative rates. The computer will just say “no” when a negative interest rate is input.
(There are work arounds - the rate can be zero and a discount on the principal is applied at the end but that’s hardly a sustainable solution.)
This current era of negative interest rates kicked off in 2014 when the European Central Bank (ECB), in an attempt to coerce banks into lending more to stimulate the economy, made banks pay for the deposits they held with the central bank.
Ideally, this would have driven more lending and more investment by companies who could borrow at lower rates, creating jobs and inflationary pressures which in turn would force up interest rates.
It hasn’t happened. More central banks have turned to negative rates together with abnormal policy actions such as quantitative easing (essentially allowing governments to print money which should also, according to the old rules, be inflationary.) Yet inflation remains stubbornly low across the developed world - including in traditionally higher inflation economies like Australia.
This perhaps shouldn’t have been that unexpected. Twenty years ago the Bank of Japan (BOJ) tried the same tactic, pushing official rates to zero. Inflation has barely budged.
Meanwhile, according to ratings agency Fitch, annual economic growth rates have been falling since mid-2018 in virtually all of the 20 large developed and emerging economies covered in the agencies major economic research.
“Annual growth in the US has been declining since mid-2018, in line with the pattern seen in China, the Eurozone and virtually all other large economies,” according to Fitch.