Frances Coppola on negative interest rates

by on February 17, 2016 at 3:17 am in Current Affairs, Economics | Permalink

Negative rates are effectively a tax on deposits, and as such are intrinsically contractionary. They are a form of financial repression. As long as banks choose to absorb that tax themselves, those who pay that tax will effectively be bank shareholders and employees. But if banks choose to pass that tax on, it will be savers and borrowers who pay the tax. Would the increased economic activity that negative interest rates may generate be sufficient to offset the effect of this tax?

Alternatively, if we think of negative rates as a monetary operation rather than a tax, we can say that the central bank drains back a small proportion of the reserves it adds to the system through QE. This is monetary tightening. Again, would the increased economic activity generated by negative rates be sufficient to offset this effect?

There is more at the link, perhaps the best exposition of this argument I have seen to date.  Here is also Jared Bernstein on negative rates.  And Scott Sumner comments.  And Izabella Kaminska comments.

1 Ben J February 17, 2016 at 3:23 am

This is the same genius reasoning that tells us that raising interest rates is expansionary because it’s a subsidy on deposits. Hmmm… let’s think about that for a while…

2 Daniel February 17, 2016 at 3:58 am

Economists are retarded.

3 Dmitri Helios February 17, 2016 at 4:46 am

Is she related to the Hollywood Coppolas?

4 Craig February 17, 2016 at 10:06 am

Coppola, didn’t he have something to do with the movie “It’s a Wonderful Life.”?

5 prior_test February 17, 2016 at 5:15 am

Apocalypse now or later?

That is the question here, right?

6 rayward February 17, 2016 at 6:52 am

Mr. Coppola is a pupil of the Charles Lutwidge Dodgson School of Economic Ideas, which is experiencing something of a comeback in economics. It’s focus is on consumption, and acknowledges that we reside in world in which the choice is either eat or be eaten.

7 carlolspln February 17, 2016 at 9:40 pm

He’s a she.

8 Ray Lopez February 17, 2016 at 7:34 am

The logical conclusion to negative interest rates is to abolish paper cash and metal coins. You watch, that will happen.

9 WC Varones February 17, 2016 at 10:22 am

Larry Summers just proposed banning high-denomination currency.

10 Different T February 17, 2016 at 10:51 am

“Toute nation a le gouvernement qu’elle merite.” Joseph de Maistre

11 Yu Feng February 17, 2016 at 8:06 am

If negative interest rate is a tax on deposit, why would borrowers pay the tax as well? Shouldn’t it be 100% on savers?

12 Yancey Ward February 17, 2016 at 10:16 am

Do you really think borrowers spend the money the instant they get it accredited to their account?

13 Alan Gunn February 17, 2016 at 8:12 am

People get to choose whether the burden of a tax gets shifted? In a sense, perhaps, just as businesses get to choose whether to give their stuff away free or charge for it.

14 dwb February 17, 2016 at 8:56 am

Of course negative rates are a tax on deposits. Duh. But so is higher inflation.

Deposit rates lower than inflation are a tax on savings (i.e. negative real rates). That is the idea of monetary stimulus using interest rates as a tool: increase taxes on savings to incentivize consumption. Negative real rates mean lower (immediate) real interest income.

The question is *always* “would the increased economic activity generated by negative rates be sufficient” to offset the decline in interest income – the fact that deposit rates are positive or negative is irrelevant. The pricing power of banks to pass through negative real rates is irrelevant.

Sigh. I am starting to think that macro economics is becoming irrelevant too.

15 Cliff February 17, 2016 at 10:19 am

Yep.

16 Dave Smith February 17, 2016 at 10:23 am

You’re just starting to think macro is becoming irrelevant?

17 Lord February 17, 2016 at 1:12 pm

In that, passing it along to depositors is not that significant. It is increased lending and passing it along to borrowers that is. It is vastly easier to persuade people to borrow who want to borrow than to drive people to spend who don’t want to spend.

18 Brian Donohue February 17, 2016 at 9:08 am

Sounds muddled. Bill Conerly’s comment on the prior post on this subject was good.

as dwb says, just generate a bit of inflation, and you don’t need negative nominal rates.

19 Dan W. February 17, 2016 at 9:28 am

Loss-aversion is an established behavioral tendency. So as much as the theoreticians wish to argue NIRP works the same as price inflation our reality is different. In fact if it was announced that all money deposits would lose 2% of their value per year there would be a wholesale change in how consumers bank. And yet the theory would say such behavior is irrational. Well guess what, people are irrational.

But people are not necessarily irrational. It is just that what matters to them is not what matters to the Monetarist. Consider that in the case of actual inflation consumers can choose substitutes or to go without an item. Prices of items may increase but not all prices go up the same percentage. Consumers will empower themselves to “beat” inflation. They may very well spend an irrational amount of effort to “beat” inflation. A wholesale tax on money via NIRP can only be beat by consumers removing money from bank accounts. And that is what they will do.

20 anon February 17, 2016 at 9:50 am

+1

21 Cliff February 17, 2016 at 10:21 am

2% is a hell of a lot. It is near the limit. 3% might be the limit. Certainly at the margin people will take out their deposits. But some money will have to stay in and that is especially true for businesses, which everyone tells us are hoarding trillions in cash.

Of course -2% in a zero-inflation environment is the same as 0% interest in a 2% inflation environment as businesses will recognize- except for the cash-holding option which has its own costs.

22 Nathan W February 17, 2016 at 6:36 pm

Individuals might spend their money or invest.

But even at -2%, this does not ensure the strong business spending case, since it is not assured that there are a lot of marginal investments which would come online by dropping to -2%.

23 Heorogar February 17, 2016 at 10:26 am

+2

Conservation of principal may be one reason depositors or investors would (effectively) pay a fee/tax to an entity to safeguard their funds from depreciation. I believe that during the Great Depression, some UST securities posted negative yields.

I think fear of deflation could be at play in negative rate decisions. A consumer/investor may decide to not buy now believing price will decline. If the price decline is greater than the negative interest charge that would be a rational act.

The abolition of (beginning with large denomination bills) cash would make negative rates more palatable.

24 Different T February 17, 2016 at 11:56 am

I think fear of deflation could be at play in negative rate decisions. A consumer/investor may decide to not buy now believing price will decline. If the price decline is greater than the negative interest charge that would be a rational act.

The more important “rational act” the Fed and other CBs are contending with is related here (the article as a whole is crap, but this point is legitimate):

As correspondent Mike Fasano noted, negative interest rates force us to save even more, not less:

“People like me who have saved all their lives realize that they their savings (no matter how much) will never throw off enough money to allow retirement, unless I live off principal. This is especially so since one can reasonably expect social security to phased out, indexed out or dropped altogether. Accordingly, I realize that when I get to the point when I can no longer work, I’ll be living off capital and not interest. This is an incentive to keep working and not to spend.”

25 dwb February 17, 2016 at 11:06 am

I am not so sure this is “loss aversion” or a difference in “what matters to them.”

Negative real rates is a definite tax on savings. But people can perceive the tax more clearly when nominal rates are negative. It is harder to perceive the tax when inflation is 2.5% and rates are zero (to some extent also because of lags in information, contract setting, etc.).

Seems to me this falls more under the behavioral finance notion that people follow rules of thumb and discount things they cannot directly observe.

26 8 February 17, 2016 at 4:20 pm

When real interest rates are negative, the economy is growing. I’m losing 1% on my deposits, but my stocks are up 20% and my salary went up 5%.

27 Different T February 17, 2016 at 11:49 am

In fact if it was announced that all money deposits would lose 2% of their value per year there would be a wholesale change in how consumers bank. And yet the theory would say such behavior is irrational. Well guess what, people are irrational.

No. Consumers have alternatives to holding deposits in a bank. Each alternative (cash, PMs, other commodities, securities, etc) comes with its own costs (primarily liquidity, storage, and/or various market/price risks).

They have no alternative to a rising price level. They can invest in securities, say TIPS, that would mitigate the impact of the rising price level, but they cannot buy goods at a counter-factual price level.

28 8 February 17, 2016 at 4:17 pm

Negative interest rates are unstable because no one sits around to take losses. Bear markets are much shorter than bull markets. It is also worth pondering that the market will choose to buy negative yield treasuries amid a banking/sovereign debt crisis. Swiss and German bond yields went below zero because losing 1% in Swiss francs is better than losing 50% on Greek New Drachma bonds.

29 Mark February 17, 2016 at 9:44 pm

Yup. Note rise in price of gold.

30 WC Varones February 17, 2016 at 9:52 am

First Jose Canseco, now Frances Coppola.

31 TallDave February 17, 2016 at 9:53 am

Frances seems awfully confused. Lower rates cannot be more contractionary than higher rates. That’s an extraordinary claim with very little evidence to support it.

Suppose the natural nominal interest rate is negative, perhaps in part because inflation is running very low or negative? We might agree that this is a sign the CB isn’t doing a good job, and that negative bond yields are bad for the economy, but that doesn’t reverse the rules of incentives — an increase in IOR creates an incentive to hold reserves and so must be contractionary, and the reverse must hold true for a decrease.

As for “repression,” Frances has also suggested the government could force banks to lend at lower rates by threatening to yank their charters, apparently not aware that capital tends to flee such regimes rather than invest at a loss, so I’d say her thinking on this topic is more than a little muddled.

32 JP Koning February 17, 2016 at 10:15 am

By this logic, any rate cut should be considered a tightening of policy, upending everything we know about monetary policy. Consider that a rate cut from +4% to +3% reduces the income banks expect to earn on central bank deposits, thus effectively acting as a tax on deposits, and as such (according to Coppola’s logic) is intrinsically contractionary. This applies as well to a cut from +1 to 0%, or -1% to -2%. They are all forms of financial repression. As long as banks choose to absorb that tax themselves, those who pay that tax will effectively be bank shareholders and employees. But if banks choose to pass that tax on, it will be savers and borrowers who pay the tax. If you really want to loosen policy, according to Coppola’s logic, you need to jack up rates quite high in order to fatten the subsidy.

33 Cliff February 17, 2016 at 10:24 am

Yes. And Sumner would say that lower rates are in and of themselves contractionary. But that is swamped by the expansionary effect of the monetary policy used to achieve them.

34 Different T February 17, 2016 at 11:12 am

By this logic, any fee for any Fed services provided to financial institutions should be considered a tightening of policy. If a bank has to pay the Fed to use the repo facility or borrow at the discount window. As long as banks choose to absorb that tax themselves, those who pay that tax will effectively be bank shareholders and employees. But if banks choose to pass that tax on, it will be savers and borrowers who pay the tax.

35 Lord February 17, 2016 at 1:25 pm

It is the expectations rabbit hole. Does a cut lead to expectations of further cuts, or does it lead to expectations of reversal? Does it spread hope or broaden despair? Does it signal a failing economy or its turn around? It won’t necessarily be consistent over time as past experience will color future expectations and our actions modify our expectations.

36 Turpentine February 17, 2016 at 3:21 pm

I don’t get the point, even less TC linking to it.

This is econ 101: any change in the real interest rate implies both a substitution and an income effect. For multiple reasons we believe that the former is stronger than the latter. Then the question becomes: do we have reasons to believe that going from 0% to -1% instead of 4% to 3% changes the relative importance of these two effects? Maybe, but I don’t see any convincing argument to that effect made in that post.

37 8 February 17, 2016 at 4:24 pm

The problem is interest rates are still highly positive. Real interest rates soared in 2008, but the central bank arrested the process. If it wants to artificially replicate what 2008 was trying to achieve, it will cut rates to negative 5% or 10% and cause a flight out of the currency.

Or they could devalue against gold and print money against their newly revalued reserve assets. $10,000 an ounce is a nice round number that will end all of this stupidity.

38 Mark February 17, 2016 at 9:41 pm

It just seems so obvious that if you wanted to stimulate animal spirits, you would not take money out of the system by taking money from people who are long cash. . You would inject money into the system by giving money to people who are short cash.

39 Mc February 18, 2016 at 6:16 pm

who got blamed for usury? who’s going to get blamed for negative-usury? huh? wuh? wtf . . .

40 Andreas Moser February 18, 2016 at 11:19 pm

I will wait for the movie to come out.

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