Our story starts in a very different time and place from today’s negative interest rates but its ending could resemble where we are heading today.
During the 1930s when the U.S. banking system appeared to be close to collapse, the Congress placed a ceiling on the interest depositors received for their savings. The goal was to limit the ways in which banks could compete. Less competition they thought meant less risky behavior from banks looking to boost their balance sheets. Not being able to lure depositors with attractive interest rates (and because of other New Deal constraints), banks behaved conservatively and few failed. All went well for 40 years.
But during the late 1970s, with interest rates rising, savers wanted a higher return. The response was the first money market funds and rates that far exceeded what the banks offered. Although they were foregoing the safety of deposit insurance, billions of dollars fled the banks for the higher return. Recognizing that the massive withdrawals threatened the banking system by creating disintermediation (which meant the banks were no longer intermediaries between savers and borrowers), Congress eliminated the ceiling.
We could say that the incentives created by 1930s banking legislation had unintended consequences. And so too could negative interest rates.
Negative Interest Rates
Now banking authorities are again experimenting. After the global financial crisis struck, central banks resorted to ZIRP (zero interest rate policy). Considered unconventional monetary policy (UMP), near zero rates were supposed to be temporary. After all, the textbooks say that low interest rates encourage us to borrow, to buy houses and cars and expand our businesses. But the textbook solutions did not quite work out and so rates have remained low with some entering negative territory.
And here is where the real experimentation begins. When interest rates are negative, we pay the banks to hold our savings. The goal however is for us to feel that paying the bank is so distasteful that instead we will spend our money, boost the economy and the inflation rate.
Maybe. No one is sure.
Our Bottom Line: Unintended Consequences
In addition, low interest rates could divert financial markets from more productive investments and distort risk assessment. And here we can return to where we began. Negative interest rates could even create disintermediation by making saving so unattractive.