Chris Waller, an economist and EVP and Director of Research at the St. Louis Fed, wrote on Monday that negative interest rates are a tax in sheep’s clothing. Waller says:
Many foreign central banks—such as the European Central Bank, the Bank of Japan and the Swiss National Bank—have implemented negative interest rates on bank reserves as a policy tool to stimulate demand for goods and services. If a bank holds a dollar of reserves, the central bank may take, say, half a cent.
The hope is that a negative interest rate will induce firms to lend out the reserves by charging a lower interest rate on loans. In short, “use it or lose it.” More lending would stimulate spending on goods and services, which would lead to higher output and upward pressure on inflation.
A Tax on Reserves
But a negative interest rate is just a tax on the banks’ reserves. The tax has to be borne by someone:
- The banks can choose not to pass it on and just have lower after-tax profits. This will depress the share price of banks and weaken their balance sheets by having lower equity values.
- The banks can pass the tax onto depositors by paying a lower interest rate on deposits or charging them fees for holding the deposits. In either case, depositors have less income to spend on goods and services.
- The bank can pass the tax onto borrowers by charging them a higher interest rate on a loan or higher fees for processing the loan. In either case, it is more costly to finance purchases of goods and services by borrowing.
None of this sounds very “stimulative” for consumer spending. But then, no tax ever is.
Negative Interest Rates in Other Countries
What has happened so far in countries that have tried negative interest rates? The figures below provide answers. As seen in the first chart, bank stock prices have definitely taken a hit. After initially continuing their downward trends, interest rates on mortgages have now risen in Germany and Switzerland (the second chart). Banks have been very reluctant to charge negative deposit rates for fear of a backlash from customers (the third chart).
At the end of the day, negative interest rates are taxes in sheep’s clothing. Few economists would ever claim that raising taxes on households will stimulate spending. So why would they think negative interest rates will?