Unconventional Monetary Policies: Negative Interest Rates and Helicopter Money
26 Apr 2016
With official interest rates close to zero and most economies still struggling for growth in the aftermath of the great financial crisis, central banks around the world are considering and in some cases introducing unconventional monetary policies to provide additional stimulus to struggling economies. One example is the decision by some of the world’s major central banks to move their official interest rates below zero. Another example is so called “helicopter money”. Although not yet implemented by any central bank, the possibility of introducing an “enhanced” form of quantitative easing (or money printing) through helicopter money is being debated among central bankers. Negative Interest Rates When you lend somebody money, they usually have to pay you for the privilege. But it is an assumption that is increasingly being cast aside by some of the world’s major central banks. Negative interest rates used to be a theoretical curiosity discussed light-heartedly amongst economists. Not anymore. Five central banks - the European Central Bank, the Swiss National Bank, Denmark’s Nationalbank, Sweden’s Riksbank and most recently the Bank of Japan - have actually decreased their official interest rates to below zero. So how do negative interest rates work? Commercial banks maintain their cash reserves electronically at a central bank. In normal times, the banks are paid an interest rate set by the central bank for reserves they keep on deposit beyond what is needed to meet regulatory requirements. Now that the ECB and other central banks have moved to a negative interest rates, the banks instead have to pay the central banks to park money there. How is this supposed to help the economy? The theory is that when it becomes costlier for banks to keep money with their central bank, they will have the incentive to do something else with it: lend it out to consumers or businesses, for example. Or if negative rates make it less attractive for global investors to park money in say Europe, it could cause the euro to fall on currency markets, helping reverse a rise in its value that has made European exporters less competitive. What are those downsides? Banks will most likely pass these negative interest rates on to consumers, or at least try to. They may try to do so not by explicitly charging a negative interest rate, but by paying no interest and charging a fee for account maintenance. It is possible that, assuming banks pass along the negative rates through either fees or explicitly charging negative interest, people will withdraw their money as cash and keep it at home in a safe or under the mattress rather than keeping it on deposit at banks. Ultra-low interest rates over a lengthy period is also a big problem for savers. In such a world, the whole set of assumptions embodied in retirement income plans will be called into question. Helicopter Money The concept is named after an essay by American economist Milton Friedman, who presented his idea by saying “let us suppose that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky.” Helicopter money essentially involves a central bank handing money directly to citizens. Like quantitative easing, it involves the central bank printing money; however, whereas the money printed under QE is used to buy debt and other securities, helicopter money is given directly to the public to spend on goods and services. It is also a permanent transfer of cash, while QE is supposed to be temporary. Alternatively, rather than giving money directly to the public, a central bank may instead give it to its government who can then spend it on say infrastructure projects to pump money into the economy and to create jobs. The prospect of helicopter money is a remote and radical one for now. But that it is being debated amongst the world’s main central banks is noteworthy. Even Glenn Stevens, governor of the Reserve Bank of Australia, discussed helicopter money in detail in a speech he made in New York recently. According to Mr Stevens, “the main complication is surely that it would be a lot easier to start doing helicopter money than to stop, if history is any guide”. Should you wish to speak to an Intralink Adviser in regards to the above, please don’t hesitate to call the office on 03 9629 1100.