Negative-interest-rate era is over. Was it the 'dumbest idea' in economic history?

By William Watts

Bank of Japan is last major central bank to abandon negative rates

The long experiment with negative interest rates is over - at least for now.

The Bank of Japan on Tuesday pushed its official interest rate back up to at least zero. Japan's central bank was the last holdout, and its decision ended a 12-year global experiment with negative interest rates that saw central banks enter uncharted waters in an attempt to stimulate major economies in the wake of the 2007-09 economic crisis.

See: Bank of Japan ends negative-interest-rate era with first hike since 2007

Denmark's central bank pushed its deposit rate below zero in 2012 as it sought to preserve its currency's peg to the euro. The European Central Bank in 2014 was the first major central bank to push rates below zero, effectively charging banks for leaving excess reserves with the bank overnight. The Bank of Japan went negative in 2016, eventually followed by central banks in Sweden and Switzerland.

In the U.S., the Federal Reserve kept the fed-funds rate effectively near, but just above, zero from late 2008 to 2015 and again from March 2020 to March 2022.

The implementation of negative rates marked a through-the-looking-glass moment for economists and central bankers, not to mention borrowers and savers. Negative rates had previously only ever been discussed in theory. The idea was that negative rates were needed to battle a deflationary funk that continued after central banks had already pushed interest rates to zero.

Headlines about banks charging customers for deposits or lenders paying mortgage borrowers created a sense of disorientation.

The COVID-19 pandemic reinforced the negative-rate regime initially.

The International Monetary Fund in 2021 concluded that initial misgivings about the policies were off the mark, saying the policies had succeeded in easing financial conditions without raising significant concerns about financial stability.

Deutsche Bank strategist Jim Reid, in a Tuesday note, said the upsides of the policy were that it lowered borrowing costs across swathes of the global economy, eased the deleveraging burden after the 2007-09 financial crisis, prevented too much hoarding of deposits and precautionary savings, and arguably helped ensure deflation didn't become entrenched.

On the downside, it likely encouraged asset bubbles as well as lending and investments in inefficient entities, thus potentially locking in low productivity, he said.

And there's also evidence that the biggest companies benefited most from ultraloose policies, potentially leading to increased market concentration that undercut competition. Negative interest rates also discouraged savings and were a drain on bank profitability, arguably affecting credit availability, Reid wrote.

Criticism was relentless. Bond guru Bill Gross warned that negative rates eroded a foundation of capitalism, namely the idea that investors can hope to get their money back with the prospect of a decent return. BlackRock CEO Larry Fink in 2016 called negative interest rates the "biggest crisis globally," doing damage to savers, retirees, pension funds and insurance companies.

Those criticisms still echo.

"I'll say something that I've said before, negative interest rate policy seen via the BoJ and mostly from the ECB and other European central banks, was the dumbest idea in the history of economics," said Peter Boockvar, chief investment officer at Bleakley Advisory Group, in a Tuesday note.

The debate will undoubtedly continue.

"My assumptions are that negative rates are anti-capitalistic and encourage a sub-optimal allocation of resources in an economy. However, we don't know what the counterfactual would have been in the decade where swathes of Europe and Japan experienced it," Reid said.

In the end, the bigger problem was perhaps that policy makers allowed a global bubble to grow that led to the financial crisis in the first place.

"After it burst in spectacular fashion, perhaps an alternative higher rate strategy would have been too painful in the short term for any politician or central banker to countenance," he said. "It may have led to superior long-term economic results and less debt overhang, but via too much immediate pain."

-William Watts

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03-19-24 1223ET

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