Liam Halligan

The Bank of Wonderland

Central banks’ latest wheeze may not boost growth, but it will have plenty of other consequences

The Bank of Wonderland
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What should we think about negative interest rates? What kind of Alice in Wonderland world are we living in when companies and households are paid to borrow and charged if they save?

Seemingly crazy, negative interest rates are spreading nonetheless. Implemented by central banks in Europe, Japan and elsewhere, they now apply in countries accounting for a quarter of the global economy. Should we be worried? Could we see negative rates in Britain?

Earlier this month, the Bank of England cut interest rates for the first time in seven years, from 0.5 per cent to a new record low of 0.25 per cent. Quantitative easing was also restarted, with the Bank set to purchase £60 billion of bonds with newly created money over the next six months, on top of £375 billion of QE since March 2009. Billed as a response to the UK’s ‘Brexit shock’, the Bank’s bold move has renewed speculation that the UK could soon go even further. Negative rates will be the talk of this weekend’s Jackson Hole summit, the annual pow-wow of leading central bankers.

Eight years on from the onset of the financial crisis and, despite huge bouts of money-printing and ultra-low rates across much of the western world, the global economy remains sluggish. Searching for new ways to boost growth, some central banks have stepped ‘through the looking glass’, setting interest rates below zero. The European Central Bank went first in 2014, followed by Denmark, Sweden, Switzerland and, earlier this year, Japan. Private-sector banks in these countries must now pay the central bank to keep their money on reserve. Investors in government bonds are similarly paying the Japanese, German and Swiss governments for the privilege of lending to them — another example of topsy-turvy economics.

The idea is that, by penalising cash on deposit, negative rates will jolt spending and encourage banks to extend loans — thereby boosting growth. There’s little evidence that this outlandish policy works, though, and increasing concern that it could soon backfire. While encouraging lending in theory, negative rates squeeze banks’ profit margins, making them less willing to extend loans. If, conversely, banks try passing on negative rates, firms and households could withdraw money, stuffing it under the proverbial mattress and denying banks a crucial funding source.

Japan has certainly seen a surge in the sale of safes since interest rates turned negative — pointing to physical cash hoarding. Across Europe, banks are exploring the cost of keeping piles of cash in vaults to avoid charges. The Swiss canton of Zug, meanwhile, in an eye-catching reversal of normality, has starting penalising those who pay tax bills early.

Faced with negative government bond yields, pension funds and other institutional investors needing returns to meet their obligations pursue an intensive ‘search for yield’ — channelling money into risky assets and stoking up the chances of another boom/bust cycle. Far from mending our economy, then, QE and ultra-low rates could provoke another crash. Even more QE and negative rates make such dangers more acute still.

As if that weren’t enough, negative rates fan the flames of international tensions — given that a big (tacit) reason central banks use them is to grab competitive advantage via currency depreciation. The result is a proliferation of currency wars, a direct descendant of the notorious beggar-thy-neighbour devaluations of the 1930s. Back then, currency conflicts contributed to a disastrous deterioration in relations between trading rivals. Today, while we’re some

way from a full-blown global conflict, protectionism is on the rise — and negative rates aren’t helping.

The biggest problem with negative rates, though, is that the policy is so weird and unnerving that it could actively discourage the very private-sector investment we need to get the big western economies back on track. Bemused by negative rates, many business bosses will be spooked completely if we venture even further down the monetary rabbit hole, and use so-called ‘helicopter money’ — with the authorities putting new money directly into every citizen’s bank account. Yet, incredibly, such measures are on the cards.

‘It would be so nice if something made sense for a change,’ says Alice, in Lewis Carroll’s classic. She could have been talking about 21st-century central banking.