The Theory Behind NEGATIVE Interest Rates
QUESTION:
Not sure if this is even possible.
Can the consumer savings interest rates go to a level at or below Zero that will drag down the lending interest rate lower?
Thus making borrowing even cheaper to stimulate the economy with more cheaper debt and punish savers.
Will our designed economic system sustain this thinking or will the system implode because people must save for banks to lend?
Even Japan had low interest rates but not zero.
Is that taboo?
Is that taboo?
Cheers,
R
ANSWER: The whole idea of moving to negative interest rates is seriously flawed and grossly misunderstood. The idea stems from the whole Keynesian concept that you lower interest rates to stimulate borrowing. That notion of stimulation not only completely failed in Japan, but as with everything else government reasons and unfortunately the talking heads just repeat, it is one-dimensional and fails to grasp that everything is connected. Lowering rates to try to “stimulate” fails for simultaneously you are destroying the fixed income of the elderly and pension funds based upon a theory that is bogus.
We have the largest database in the world. That has come in handy in combination with the Adam Smith approach of staying unbiased and letting the data speak instead of the Marx-Keynesian approach of trying to force the free markets to do as you think best. When we step back and try to just figure out HOW THE ECONOMY works as did Smith, what emerges from the data is quite interesting.
The business cycle has NEVER peaked twice with the same level of interest rates. Just look at the call money rates from the NYSE from 1880 to 1932. Likewise, interest rates collapse with the business cycle NOT because you will stimulate demand, but because demand collapses. That demand will return ONLY when the expectation of future gain reappears regardless of the level of interest rates. Consequently, the real formula is:
Economy Turns Up = (Expectation of Gain > Rate of Interest)
Therefore, lowering the rate of interest alone will not stimulate the economy. We have to take in account the entire picture. If you are raising taxes diminishing the disposable income, then you are creating more damage without any hope of stimulating spending that is not available.
I have explained that government’s approach is not only seriously flawed in thinking that rates alone will do anything, but then they fail completely to actually implement a policy. During the TARP bailout, all they did was hand the banks money and HOPE it will lead to lending. It never does. NOT EVEN ONCE!
Right now, deposit rates collapse because that is controlled by the central bank, but they then do not regulate the lending rates – DAH! We have ended up with the historical high in the spread between what banks pay depositors and what they charge. Therefore, going negative will still not stimulate, but it may at last force people to invest without borrowing shrinking the bank deposit base and ONLY then will banks start acting like banks. The money center banks have been trading to make profits NOT lending. Why lend when you can trade for less risk? This is why I am against banks being traders. That is a hedge fund – not a bank.
