Do negative nominal interest rates make sense?

J.L.M. Campuzano (Spanish Banking Association) | Negative interest rates are starting to become a usual thing, although there are some very different arguments for their implementation. These range from the need to resist currency appreciations and/or provide greater monetary stimulus. Overall, an additional instrument to improve financial conditions and promote a certain stabilisation of exchange rate tensions.

So do negative nominal interest rates make sense? If we admit that holdings of cash imply costs (storing, insuring and transaction), the floor for interest rates should in fact be those costs. At least considering the current alternatives for investors to place their stock. One of the most obvious is bank deposits. But what are the potential problems with these? The previous question, like all of those about exceptional expansive monetary measures, refers precisely to their duration.

The risk that exceptional measures become the norm. And I am making this slight clarification today precisely because we will have the FOMC’s final decision. There are discussions about the costs of negative interest rates in the short and medium-term. Those with a short-term focus concentrate on the functioning of payment systems, loan contracts and even the fiscal dimension. But its the medium-term costs which cause greater concern. Particularly with regard to what is referred as the potential negative impact on consumption (greater savings activity to offset lower yields) and on lending (reduction in margins leading to credit contraction). And the possibility that they could fuel excesses in investment (in prices and in size).

How relevant are these potential negative effects? I admit that I can offer no clear answer to this question. And this is undoubtedly an additional negative factor. Uncertainty is never a good thing. And negative interest rates, which are a distortion, are a source of uncertainty when economic players are positioning themselves for the future.

*Image: Flickr / debt-eyes