I recently argued that negative rates are just another tax on the private sector, and are no incentive for bank lending to households and firms. In my view, with interest rates below zero the economy will freeze up. Alan Blinder has argued exactly the opposite. For Blinder,
If the Fed turned the IOER [interest on excess reserves] negative, banks would hold fewer excess reserves, maybe a lot fewer.
Should a professional economist make sure he fully understands monetary operations before he makes recommendations on how to revive the real economy? I think he should, and so he should probably know that banks have no way of getting rid of reserves unilaterally. Banks cannot reduce excess reserves just because they do not like the interest rate they earn on them. This is the well-known problem with excess reserves as “hot potatoes”:
Participants all try to get rid of excess reserves because holding them is costly. However, the supply of excess reserve balances is fixed by the central bank and, at any point in time, someone must be holding them. (Keister et al, page 50)
Blinder claimed that banks would
find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want.
So Blinder likes negative rates because he thinks that banks would prefer making loans to get rid of reserves rather than avoiding paying interest on holding them. However, he should acknowledge what he (hopefully) teaches, namely, that:
a) Banks do not hold excess reserves because they choose to. The overall (end-of-day) balance of bank reserves depends on the net payments between the banking system and the public sector (including both the central bank and the government), and does not depend on banks’ choices about how to allocate their assets. Excess reserves are only being drained when the ECB carries liquidity absorption operations (such as reverse repos).
b) When there are excess reserves, the opportunity cost of holding reserves is zero, irrespective of the rate paid (or charged) by the ECB on excess reserves. Market interest rates always move towards indifference levels. This means that if the ECB sets a negative rate on excess reserves, banks will lower the interbank rate below zero. A negative rate does not affect the opportunity cost of holding reserves.
c) Lending is not constrained by reserves. The funding cost of a new loan for a bank is the opportunity cost of reserves, no matter what the size of reserves that the bank owns when it decides to make a new loan.
d) An ECB interest rate cut on excess reserves will further lower banks’ (and their clients) net worth and will not create a better environment for bank lending. A negative rate will drain financial assets from the banking system. Banks may partly pass this through to depositors, so a sure effect is a lower net worth of the private sector.
For more comments on Blinder’s article, I recommend you read Warren Mosler’s in-text commentary.
On the ECB front, we hear mixed signals: ECB Executive Board member Joerg Asmussen said that the ECB has a host of tools to choose from, including negative interest rates. On the other hand, ECB Governing Council member Bostjan Jazbec said he finds negative interest rates “a very difficult concept to understand, personally” and that the ECB is “still very far away from any extreme measure.” ECB Governing Council member Ardo Hansson made a similar statement.
José Viñals, director of the IMF Monetary and Capital Markets Department, is in favor of negative rates. Quite differently from the cautious ECB officials, Viñals admits that
we have very little experience with this [negative rates], but I think the signaling value is very important. I think that would be very welcome in terms of confidence.
How confidence will originate from an additional tax on the private sector Viñals did not explain. And what’s most worrying is that an IMF Financial Counsellor chooses to advise central bankers to act, on such a flimsy basis.