Negative interest rate policy raises doubts over impact on capital markets; IMF supports ECB’s stance

12 September 2016, 15:44
Eko Rediantoro

The negative interest rate policy has raised doubts over the potential impact on capital markets as the debate about whether a negative interest rate policy (NIRP) helps or hinders the transmission mechanism of monetary policy continues to rage.

However, International Monetary Fund analysts defend the European Central Bank’s negative deposit rate on the weak growth that has now persisted in the eurozone for almost a decade, seeing it as a problem of lack of demand, which can be tackled by adopting an expansionary fiscal policy and an ultra-loose monetary policy.

The central bank is using negative deposit rates to try to prevent the money supply that it has created from disappearing into speculators pockets, a situation which Keynes described as the liquidity trap, and which makes monetary policy ineffective. If the holding of cash is now penalized by negative interest rates, it could be possible to escape from the liquidity trap by encouraging banks to lend, companies to invest and consumers to spend, Deutsche Bank (DB) reported.

Like the ECB, the IMF also says that negative nominal interest rates can prevent excessively high real interest rates, which result from excessively low inflation, from unduly depressing demand. What is known as the natural rate of interest plays a key role in this approach. It describes the level of interest rates at which monetary policy fails to change the growth or inflation rates.

Moreover, NIRP reduces the incentive to change this, both for lenders because of lower profits resulting from falling interest margins and for borrowers, whose interest expense continues to decline. The eurozones crawling growth is likely to persist if companies do not write off their misinvestments and banks their non-performing loans. Negative interest rates will only stretch this process with evergreen and zombie loans, the report added.

Share it with friends: