The Bank of England is wondering whether to rob you of some of your savings. OK, that’s a bit strong. Nevertheless, in the light of the unprecedented economic contraction now taking place, the Bank is considering whether to turn conventional monetary policy on its head, creating conditions in which people are paid to borrow and punished for saving.
In March, the Bank’s Monetary Policy Committee cut Bank Rate — the interest rate which effectively determines borrowing costs on the High Street — to a mere 0.1 per cent. Since then, committee members have suggested that negative rates may now be on the cards, even if Andrew Bailey, the Governor, said last week that “it is also important that we consider very carefully the issues that such choices would give rise to”.
Negative rates have already been seen elsewhere, notably in Switzerland, Sweden, Denmark, the eurozone and Japan. All of these economies have suffered from excessively low inflation or outright deflation. Some have ended up with excessively high house prices (Sweden, most obviously). None has created conditions in which the original descent into negative interest rate territory has been reversed with any degree of confidence.
The obvious problem with negative rates is that cash exists. In the event that interest rates dropped too far below zero, savers would be justified in removing money from their bank accounts and burying it in their gardens, stuffing it under their mattresses or — more plausibly — storing it in a secure vault. Banks would no longer be able to lend and the economy would come to a grinding halt.
In the Bank’s favour, there’s no sign of that happening in the aforementioned economies. And, with Covid-19 pushing all of us closer to a contactless and cash-free economy, it may well be that the Bank has more wriggle room that it had just a few months ago.
Covid-19 pushing us closer to a cash-free, contactless economy may give the Bank more wriggle room
Even so, a more minor version of the same effect may still happen. Banks traditionally make money through the “spread” between the interest rate offered to depositors and the interest rate demanded from borrowers. With negative interest rates, banks would effectively have to take money out of savers’ bank accounts, a deeply unpopular outcome. In the face of this banks might end up letting lending rates fall more than deposit rates, in effect cutting the “spread”. That, however, would lower bank profitability and reduce the volume of lending, the opposite of what policymakers would be hoping for. Borrowing costs would be lower, but a dwindling proportion of people would actually be able to get access to credit.
The biggest objection to negative interest rates, however, is that they have the same redistributional consequences as periods of unexpectedly high inflation. In the 1970s, those with cash savings — pensioners, most obviously — ended up poorer as a consequence of inflation being continuously higher than interest rates. Now, the Bank of England is thinking of doing roughly the same thing, this time by making sure that interest rates are continuously lower than inflation (even when inflation itself is excessively low).
Dressed up in the language of monetary policy, it is easy enough to dismiss this as no more than a technical debate with no relevance for the man or woman on the street. Imagine, however, that such a policy was enacted by a government, and dress it up in the language of fiscal decision-making instead. In effect, the government would be imposing a “wealth tax” on those with cash savings, using the revenues raised to offer mortgage interest relief to would-be property purchasers. In the process, house prices would end up higher, benefiting existing owners, including buy-to-let landlords.
Suddenly, a seemingly innocuous monetary policy decided upon by technocrats in Threadneedle Street would turn into a politically charged fiscal decision. If negative interest rates only end up redistributing the existing economic cake rather than increasing its size, they will surely lead to greater political scrutiny for an institution that hugely values its hard-won independence. The Bank now needs to be completely transparent about the Governor’s “issues”. In other words, Mr Bailey, won’t you please come clean?
Stephen King (@kingeconomist) is HSBC’s Senior Economic Adviser and author of Grave New World (Yale)