The best central bank policy for our times is “masterly inactivity”by Andrew Sentance / May 29, 2020 / Leave a comment
Andrew Bailey, who recently took up his new post as Governor of the Bank of England, has caused a stir by speculating about the possibility of negative interest rates arriving in the UK. He told a parliamentary committee that it would be “foolish” to rule out such a policy. His colleague Andy Haldane—the Bank’s Chief Economist—has been musing publicly along the same lines.
Japan, the eurozone, Switzerland, Sweden and Denmark have all introduced negative rates in some form over the past decade. President Trump has occasionally advocated a similar policy for the United States. So should the Bank of England be following the same path?
In one sense, this is not such a radical departure. Here in the UK interest rates have been negative in real terms—ie adjusted for inflation—since 2009. Since the official Bank Rate was cut to 0.5 per cent in March 2009, the average official borrowing rate has also averaged 0.5 per cent while inflation has been 2.3 per cent. That is a negative real interest rate of nearly 2 per cent.
However, this policy of negative real interest rates has already provided a foretaste of the problems which a headline below-zero rate could bring. Savers have struggled to find adequate returns on their investments. The returns available to pension funds have been badly hit. And many economists believe that prolonged near-zero rates have blunted the incentive for businesses to look for efficiency improvements—contributing to low productivity growth.
These problems would all be reinforced if the headline interest rate actually went negative. But there are some powerful additional arguments against this policy.
First, it would undermine one of the traditional roles of money in society—as a store of value. In a negative interest rate world, money held on deposit erodes in value year by year. The erosion in the value of money is a key reason why we have become so averse to inflation. So it would be perverse to institutionalise the erosion as a deliberate policy.
Second, it is far from clear that a policy of negative rates would be effective in stimulating the economy—which is normally the main reason for cutting them. In Japan and the eurozone there is evidence that negative interest rates have eroded business and consumer confidence, rather than restoring it. When…