Guest Post: Negative Nominal Interest Rates?

Tyler Durden's picture

Submitted by John Aziz of Azizonomics blog,

A number of economists and economics writers have considered the possibility of allowing the Federal Reserve to drop interest rates below zero in order to make holding onto money costlier and encouraging individuals and firms to spend, spend, spend.

Miles Kimball details one such plan:

The US Federal Reserve’s new determination to keep buying mortgage-backed securities until the economy gets better, better known as quantitative easing, is controversial. Although a few commentators don’t think the economy needs any more stimulus, many others are unnerved because the Fed is using untested tools. (For example, see Michael Snyder’s collection of “10 Shocking Quotes About What QE3 Is Going To Do To America.”) Normally the Fed simply lowers short-term interest rates (and in particular the federal funds rate at which banks lend to each other overnight) by purchasing three-month Treasury bills. But it has basically hit the floor on the federal funds rate. If the Fed could lower the federal funds rate as far as chairman Ben Bernanke and his colleagues wanted, it would be much less controversial. The monetary policy cognoscenti would be comfortable with a tool they know well, and those who don’t understand monetary policy as well would be more likely to trust that the Fed knew what it was doing. By contrast, buying large quantities of long-term government bonds or mortgage-backed securities is seen as exotic and threatening by monetary policy outsiders; and it gives monetary policy insiders the uneasy feeling that they don’t know their footing and could fall into some unexpected crevasse at any time.


So why can’t the Fed just lower the federal funds rate further? The problem may surprise you: it is those green pieces of paper in your wallet. Because they earn an interest rate of zero, no one is willing to lend at an interest rate more than a hair below zero. In Denmark, the central bank actually set the interest rate to negative -.2 % per year toward the end of August this year, which people might be willing to accept for the convenience of a certificate of deposit instead of a pile of currency, but it would be hard to go much lower before people did prefer a pile of currency. Let me make this concrete. In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.) That would be a good enough deal that the company might move up its schedule for building the factory.  But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.  The fact that people could store paper money and get an interest rate of zero, minus storage costs, has deterred the Fed from bothering to lower the interest rate a bit more and forcing them to store paper money to get the best rate (as Denmark’s central bank may cause people to do).


The bottom line is that all we have to do to give the Fed (and other central banks) unlimited power to lower short-term interest rates is to demote paper currency from its role as a yardstick for prices and other economic values—what economists call the “unit of account” function of money. Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars. More and more, people use some form of electronic payment already, with debit cards and credit cards, so this wouldn’t be such a big change. It would be a little less convenient for those who insisted on continuing to use currency, but even there, it would just be a matter of figuring out with a pocket calculator how many extra paper dollars it would take to make up for the fact that each one was worth less than an electronic dollar. That’s it, and we wouldn’t have to worry about the Fed or any other central bank ever again seeming relatively powerless in the face of a long slump.

First of all, I question the feasibility of even producing a negative rate of interest, even via electronic currency. Electronic currency has practically zero storage costs. What is to stop offshore or black market banking entities offering a non-negative interest rate? After all, it is not hard to offer a higher-than-negative rate of interest for the privilege of holding (and leveraging) currency. A true negative interest rate environment may prove as unattainable as division by zero.

But assuming that such a thing is achievable, I think that a negative rate of interest will completely undermine the entire economic system in clear and visible ways that I shall discuss below (“white swans”), and probably also — because such a system has never been tried, and it is a radical departure from the present norms — in unpredictable and emergent ways (“black swans”).

Money has historically had multiple functions; a medium of exchange, a unit of account, a store of purchasing power. To institute a zero interest rate policy is to disable money’s role as a store of purchasing power. But to institute a negative interest rate policy is to reverse money’s role as a store of purchasing power, and turn money into a drain on purchasing power.

Money evolved organically to possess all three of these characteristics, because all three characteristics have been economically important and useful. For central bankers or economists to try to strip currency of one of its essential functions is to risk the rejection of that currency.

How would I react in the case of negative nominal interest rates? I’d convert into a liquid medium that was not subject to a negative rate of interest. That could be a nonmonetary asset, a foreign currency, a digital currency or a precious metal. I would actively seek ways to opt out of using the negative-yielding currency at all — if I could get by using alternative currencies, digital currencies, barter, then I would.  I would only ever possess a negative-yielding currency for transactions (e.g. taxes) in which the other party insisted upon the negative-yielding currency, and would then only hold it for a minimal short period of time. It seems only reasonable that other individuals — seeking to avoid a draining asset — would maximise their utility by rejecting the draining currency whenever and wherever possible.

In Kimball’s theory, this unwillingness to hold currency is supposed to stimulate the economy by encouraging productive economic activity and investment. But is that necessarily true? No — it will just drive people away from using the currency as a store of purchasing power. So long as there are alternative stores of purchasing power, there is no guarantee that this policy would result in a higher rate of  economic activity. Indeed, its side-effects may drive economic activity much lower.

But it will drive economic activity underground. While governments may relish the prospect of higher tax revenues (due to more economic activity becoming electronic, and therefore trackable and traceable), in the present depressionary environment recorded and taxable economic activity could even fall as more economic activity goes underground to avoid negative rates. Increasingly authoritarian measures might be taken — probably at great cost — to encourage citizens into using the negative-yielding legal tender.

Banking would be turned upside down. Lending at a negative rate of interest — and suffering from the likely reality that negative rates discourages deposits — banks would be forced to look to riskier or offshore or black market activities to achieve profits. Even if banks continued to lend at low positive rates, the negative rates of interest offered to depositors would surely lead to a mass depositor exodus (perhaps to offshore or black market banks offering higher rates), probably leading to liquidity crises and banking panics.

As Isabella Kaminska wrote in July:

The simple fact of the matter is that in a negative carry world – or a flat yield environment for that matter  there is no role or purpose for banks because banks are forced into economically destructive practices in order to stay profitable.

Additionally, a negative-yielding environment will result in reduced income for those on a fixed income. One interesting effect of the present zero-interest rate environment is that more elderly people — presumably starved of sufficient retirement income — are returning to the labour force, which is in turn crowding out younger inexperienced workers, who are suffering from very high rates of unemployment and underemployment. A negative-yielding environment would probably exacerbate this effect.

So on the surface, the possibility of negative nominal rates seems deeply problematic.

Japan has spent almost twenty years at the zero bound, in spite of multiple rounds of quantitative easing and stimulus. Yet Japan remains mired in depression. The fact remains that both conventional and unconventional monetary policy has proven ineffective in resuscitating Japanese growth. My hypothesis remains that the real issue is the weight of excessive total debt (Japan’s total debt load remains as precipitously high as ever) and that no amount of rate cuts, quantitative easing or unconventional monetary intervention will prove effective. I hypothesise that a return to growth for a depressionary post-bubble economy requires a substantial chunk of the debt load (and thus future debt service costs) being either liquidated, forgiven or (very difficult and slow) paid down.

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hedgeless_horseman's picture



... it will just drive people away from using the currency as a store of purchasing power. So long as there are alternative stores of purchasing power, there is no guarantee that this policy would result in a higher rate of economic activity. Indeed, its side-effects may drive economic activity much lower.

Got (90% Silver) pocket change?

Popo's picture

We already have negative nominal interest rates when one considers the rate of inflation.  

sickofthepunx's picture

that would be "real" interest rates genius

MillionDollarBogus_'s picture

Japan now has so much public debt their central bank is forced to keep the rate near zero.  Have seen mention several times recently that if interest rate there went up to 2%, all of the money flowing to their treasury would be used to service new debt.  There would be nothing left over to keep the government running.    

We are rapidly heading down that same path. 

If QE3 doesn't work, what else is left to try..??

AldousHuxley's picture

US Treasury long term rates = INFLATION


add taxes to your interests and you have a loss



Half_A_Billion_Hollow_Points's picture

FUN FACT: in 13 days, the ratio between new bitcoin creation and new usd creation will be 800,000USD per 1 Bitcoin.

monkeyshine's picture

Correct. And it hasn't helped much and won't for reasons stated in the article and more. They already printed and handed out too much cash which is now for many reasons hoarded in too few hands. Those with the cash either can't invest it or won't. Those who need cash can't qualify to borrow it. Those who could qualify to borrow it don't need or want to. I don't know which economy this central bank is looking at, but the one I am operating in wont respond to the kinds of stimuli they are talking about. I have thought it was a liquidity trap for a long time, maybe it is, or some variation of one.

Anyway even if real interest rates are negative if those who have it are otherwise breaking even they won't care. We are going to destroy the American dream and install an oligarchy of the wealthy. Those who dare earn enough money to become rich will be taxed heavily to get there. Those who are already wealthy you don't have to worry. Everyone else pays as they go hand to mouth.

Dr. Richard Head's picture

I was going through my basement last night, as I am going to stud it out, and ran across a pile of 1881 Morgan silver dollars that my grandfather held on to.  Some Greek drachma coins, as well.

Dapper Dan's picture

Leave us your address and we will come over tonight and help you frame up the walls.


max2205's picture

that's the most fucked up idea I've ever heard

venturen's picture

At the drachmas are worth something!

yrbmegr's picture

Negative interest rates will only convince people to close their bank accounts and park that money in assets.  It will not necessarily convince them to spend it.

Ballin D's picture

Thats might be logical but our inflation rates are already negetive, depending on your 'opinion' of how much inflation there is.


Now we just need to figure out how to make everyone act in a logical manner and everything is fixed!

mkkby's picture

If rates were negative, then essentially gold WOULD pay a dividend.  Deposit accounts would be drained.  Bye, bye banks.

Please do it, Bernanke.

PUD's picture

Why do the rational thing when dreams of ponies are more pleasant?

AnAnonymous's picture

But 'american' nations's economy keeps growing...

They keep growing the same way as they used to do in the past.

The slight difference in today's scenario: 'americans' who thought that their 'american' status should be marbled in stone over generations and all have troubles accepting it wont be the case, that, alas, alas, triple alas, 'americanism' needs to be fed and be fed fat people. And people who got fatter and fatter during the american centuries are the 'american' middle class...

Just do as usual and one sees that 'american' nations' economy is growing. Trouble is that people who are no longer part of the 'american' club keep insisting they are still members...

thedrickster's picture

apart from the obvious, WTF you talking 'bout Pang. I would note that if you fuckers keep digging on KFC, your waistlines will look exactly like americans but with a lower center of gravity.

Bicycle Repairman's picture

You're just repeating stuff that contains very little informational content.  You've devolved into a complainer and a gadfly.  I suspect you could do better.

Bicycles and Beer's picture

i bumped your reply soley because of your exceptional nick.

Titus Flavius Caesar Vespasianus Augustus's picture

The expansion of debt isn't real economic growth - economists just think it is.


American prosperity was built on having the reserve currency/petro dollar, and borrowing lots of money.


But a dim understanding that this is the case doesn't mean that you're not kind of a cunt.

Ballin D's picture

We seriously need to stop the hate on fat people.


Long heart attacks for the 50+ folks.  Let them solve the boomer problem themselves.

q99x2's picture

Secede from the FED

RSloane's picture

I'm so sick of those fuckers. My grandmother and her iron box of cash under the floorboards of her fruit cellar had the right idea. No matter how much the banks and TPTB tried to screw her out of her savings, it was safe.  I will not ever pay a bank to hold onto my money. Screw them, I hope they all fall.

fonzannoon's picture

Exactly RSloane. I double fuckin dare them to make those rates negative. People are sick of this. At negative rates cash will be pulled from banks now that EVERYONE owns a gun and will be more apt to defend themselves. Won't take much of a run on these banks to croak them. Lets do it.

Hey ZH you jusy got a plug from guy talking to Santelli about MFG

RSloane's picture

Nothing is going to wake up these 'central planners' until people line up in droves in banks and demand loudly that they be given their money. They don't respond to anything else.

Ballin D's picture

Im not sure this is a bad thing.  Theres no better way to get the masses to spend money frivolously than to have them hold it as FRNs

sudzee's picture

Just reduce credit card rates to 3%.

James-Morrison's picture

Why stop at 3%. Let's make it -3%.

Schmuck Raker's picture

First, we need a whole new government entity to study this...

Spastica Rex's picture

Drop iPhones out of helicopters. Put little parachutes on them so they don't hurt if they hit people in the head.

faustian bargain's picture

All's they gotta do is put expiry dates on all the FRNs, and tax all non-investment accounts at 10% per month. Problem solved.

That, or unleash a deadly virus that wipes out the bottom 90% of the population. That could work too.

Peter Pan's picture

What fools. Won't a negative rate of interest simply encourage people to withdraw their cash and keep it at home? In other words there will be a bank run.

If they want to play games they should instead issue money that has an expiry date of 6 months. As the end date approaches it will worth less and less until it dies.

optimator's picture

"They" are already doing that, but only "They" know the expiry date.

whotookmyalias's picture

In other news, stupid is still stupid no matter how you try to spin it.

XitSam's picture

"...  banks would be forced to look to riskier or offshore or black market activities to achieve profits."

All acording to plan. What's the problem?

Bastiat's picture

Negative real rates negate an essential monetary criteria: store of value.  Got Gold? Got Silver?

Aziz's picture

Negative nominal rate = super negative real rate.

I am more equal than others's picture

Real interest rates have been negative for a long time. 

ZIRP - Rate of inflation = real rate

from blowing bubbles to blowing up.  Just push Command 'P'

Titus Flavius Caesar Vespasianus Augustus's picture

It seems to me that the US had a reasonably prominent politician who expended a great deal of energy to, at a minimum, audit the federal reserve.

The MSM didn't much cover it, the American people didn't much care, and when it did get to the Senate, in watered-down form, the Democrats, the party of truth, justice, sunshine, puppy dogs and free ice cream - promised to stop any such efforts cold.

For goodness sake, when foreign countries, pursuant to legally binding treaty, ask for an accounting or inspection of their own gold, the Fed simply ignores it.


There can be no meaningful reform of the economy or economic system {especially with regard to those of us who actually invent, manufacture or innovate rather than trading around debt or lending capital} when you have an above-the-law, parasitic, apparently essentially foreign-owned cartel of banks calling the shots.


Negative interest rates to prolong "the economy" and allow large investment banks to consolidate and buy up more and more real property and other assets on the cheap is simply par for the course - robbing labor and savings to enrich lenders and those who control "the issuing power."


Maybe I'm just preaching to the choir - but my point is, the Fed itself orchestrates what amounts to wealth transfer - value transfer - from productive work to those who have lots of capital amassed and those who can simply create money.


Congress is unwilling to challenge this set up -and let history reflect that Democrats are every bit as complicit.  They have made peaceful revolution impossible, and the game seems to be to run up the debt and deflate everyon'es purchasing power so the central bank can get more and more power through buying real shit....  and, I think, by "forgiving" a big part of the public debt{s} in exchange for exclusivity in the ability to create money out of nothing.


The issuing power must be restored to The People, to whom it properly belongs.





Ident 7777 economy's picture

-1 Not so subtle Ron Paul plug, and no, he was not really 'prominent'. 


Jon Stewart, he is prominent ...

Urban Redneck's picture

That quote wasn't stupid it was scary stupid.

Here's an alternative NIRP scenario-

 Because of the carrying costs for keeping money in banks or bonds in a NIRP environment, demand for physical cash (M0 ) increases.  Significant M0 increases would be the Great De-Sterilization.

Spastica Rex's picture

I'm going to come out and say that I'm no genius, and that I really don't understand a lot of things, and that I really feel very ambiguous about most economics.


Kimball's logic seems extremely tortured to me, to the point of obfuscation.

Anasteus's picture

That's exactly what I wrote about nearly 3 months ago in my comment as a joke.

... which means it's more and more difficult to come up with whatever stupidity that wouldn't come true sooner or later.

Paper CRUSHer's picture

As we all well know Japan's perpetual zero percent interest rate policy has done wonders for the economoney and the major companies in general such as driving the stock price of Sony to a 32 year low today.........r-r-rewind back to the 80's....where the hell is my Walkman?

Negative interest rates by the BOJ will no doubt help the Nikkei and Sony's stock price to recover...........hah.


Money Squid's picture

Where are all of you Bitcoin nut jobs now?

Spoof the chain bitches.

Withdrawn Sanction's picture

Japan has spent almost twenty years at the zero bound, in spite of multiple rounds of quantitative easing and stimulus. Yet Japan remains mired in depression.

Japan remains mired in depression BECAUSE of 20 years at the zero bound.  The US is headed in the same direction and for the same reason.  Negative real rates retard capital formation and impede the liquidation of unsound debts and debtors.