The Bank of England must not implement this perverse policyby Andrew Sentance / October 29, 2020 / Leave a comment
Will the Bank of England soon join the European Central Bank (ECB) and the Bank of Japan in taking its official interest rate into negative territory? Speculation was fuelled a few weeks ago when the Bank wrote to financial institutions asking them how they might implement such a policy, if it were put in place.
The idea of negative interest rates seems perverse. Surely savers should receive a positive return on money they invest with a bank and borrowers should pay a reasonable interest charge on their loans? But since the Global Financial Crisis, we have been living in a world where the normal rules of finance don’t always apply.
We have already had a negative real interest rate in the UK for over a decade. The official Bank Rate has fluctuated between 0.1 per cent and 0.75 per cent, compared with an inflation target of 2 per cent and actual CPI inflation averaging just above that figure.
However, the Governor of the Bank of England Andrew Bailey has refused to rule out setting the official Bank Rate below zero for the first time in the UK. He describes a negative interest rate as part of the “monetary tool kit,” though not one that the Bank’s Monetary Policy Committee is yet ready to deploy.
So what kind of tool is it? Europe and Japan have had a negative interest rate since the mid-2010s. It applies to deposits held by commercial banks with the central bank. In the case of the ECB the rate is -0.5 per cent and in Japan it is -0.1 per cent.
The rationale behind this policy is to encourage the private sector banks to lend out money at positive interest rates to their business customers and individuals, rather than keeping money on deposit with the central bank. This might be a legitimate argument if the cautious behaviour of banks was the main impediment to lending in the economy at the moment.
However, in the pandemic, the main impediment to normal lending is the massive shock to the economy and the way this has disrupted business activity and the financial prospects of households. This has increased the risks attached to all types of lending, and borrowers have become much more cautious as their financial prospects have become much less secure.…