Why Germany doesn’t like negative interest rates

The business models of German financial institutions depend critically on the presence of positive nominal interest rates. The International Monetary Fund noted in its latest Financial Stability Report that the pre-tax profits of German and Portuguese banks are most affected by negative rates.

German life insurers are also vulnerable. They have to guarantee a minimum rate of return, which is now 1.25 per cent a year. This is hard to do when the yield of the 10-year German government bond is only 0.13 per cent. Germany and Sweden are the two EU countries where life insurers face the biggest gap between market rates and guaranteed rates. To achieve the promised returns, the insurers have to take on more risk, for example by buying corporate bonds or tranches of complex financial products. If, or rather when, the next financial crisis arrives and triggers a change in the valuation of these assets, we may find that sections of the German financial sector are insolvent.

Of the German banks, the Sparkassen and the mutual savings banks are most affected. They are classic savings and loans outlets in that they lend locally and fund themselves through savings. Credit demand is more or less fixed. So when savings exceed loans, as they now do in Germany, the banks deposit their surplus with the ECB at negative rates — known as “penalty rates” in Germany. They cannot offset the losses by cutting interest rates on savings accounts because of the zero lower bound. Savers would switch from accounts to cash in safe deposit boxes.

That is from the always superb Wolfgang Münchnau at the FT.  Regulatory and federalistic issues are another and underdiscussed reason why the eurozone is not an optimal currency area.


In that case, Germany should like more of a "whatever it takes" approach from the ECB.

Not if the ECB thinks 'whatever it takes' involves lower and lower negative rates, as they apparently do.

Low rates in the very short run lead to _higher_ rates in the medium-long run. Think Fisher effect.

One would think. Still waiting.

It's April. Since April one, I have to pay another percentage point of my income to my Dutch pension fund, the ABP. Not because it has or had low returns. The contrary is true - it seems to understand that it can invest 'long'. But because bureaucrats at De Nederlandsche Bank, part of the ECB, stipulate that we have to expect that interest rates will be as low as they are 'forever'. As a consequence, the interest rate set by De Nederlandsche Bank to discount the value of the obligations of the pension funds is extremely low. Which of course causes this discounted value to be quite high. Which means that we have to save more.

I'm not of the opinion that low interest rates as such are 'caused' by the ECB, though low rates on Italian and Spanish government debt is surely enabled by the ECB. The ECB has no other choice than keeping those rates low, by the way. And Draghi deserves kudo's for finally, finally getting household and company rates in south Europe and household rates in the Netherlands (!) down.

But there is something awkward about the fact that the ECB, Frankfurt, tries to get rates down and uses low and even negative interest rates to get saving down and consumption and investment up while at the same time the ECB, Amsterdam (which for one reason or another has the e-nor-mous power to set the rates used to discount the obligations of the pension funds) sets other rates which drive financial savings up and consumption down.

Low rates are not the only reason why the Dutch have to save more and more and more (remember: De Nederlandsche Bank recently also issued a press release which stated that the current account surplus had declined (headline). To +9,8% of GDP (small print)). De Nederlandsche Bank (again) has also stipulated that the value of the assets of the Dutch funds, at this moment a measly 1,7 trillion, or something like 2,2 times Dutch GDP, has to rise from it's present value of about 97% of calculated obligations to 128% of these obligations. Or about 3 times Dutch GDP. Which is - a lot (Piketty calculates that the total amount of wealth of western countries is at this moment in time about 6 to 8 times GDP).

Draghi has a problem. And New Keynesian models too, a more institutional approach is needed.

An interesting question is of course: 'who will, in the future, own the 28% equity of the funds'. The whole idea of 28% 'equity' in a mutual pension fund is of course weird and too much a long term strategy, when you think it through.

The primarily American audience of this blog may not be aware that DNB is not actually part of ECB (it's not like, say, the Kansas City Fed).

This sounds like a list of bad business practices rather than reasons why negative rates are bad. The article basically makes two criticisms:

1) "Firms have to guarantee a 1.25% rate of return." Well, gee, mandating firms pay a minimum rate of return that's above market rates is a bad idea? Who knew?

This is obviously a ridiculous regulatory requirement rather than a problem with the level of interest rates.

2) "Savers will stick their money in the mattress if you try to charge them negative rates." So? Isn't the problem that banks have excess reserves on which they're paying interest? Isn't the solution to that problem to have less in excess reserves?

Why do banks continue to offer depositors such generous terms when the cost of serving those depositors is higher than the revenue generated by those customers. Raise the price on the lowest value depositors and let them leave. Most won't because they still need/want the other services that come with having a bank account.

And that's what policy makers want anyway: make it painful to horde cash.

The insurers themselves did the guaranteeing, not the government. Try reneging on your old contracts, I assure you it's more expensive than simply paying up the 1.25%. With the new German bankruptcy laws, which make discharging shareholders easy, I assure you that even bankruptcy would be cheaper than facing off your clients.

Economists argue savers will spend the cash buying stuff for the future in expectation of higher prices, and economists are always right.

They should be buying toilet paper and putting it in safety deposit boxes, or at least stuffing it under their bed. Canned food. Old people clothes, diapers, ...

Then they will be able to live in part off their savings in old age instead of seeing their cash shrink from the negative interest rates.

Gee, you mean there is no re-allocation of nominal resources that doesn't re-allocate real resources, and there is no re-allocation without losers? Well I'll be.

Switch to a deposit safe? I doubt it.

"Switch to a deposit safe? I doubt it."

Assuming that you can get insurance on the contents of the deposit safe, why not?

The insurance payments would effectively be negative interest, plus the fixed cost of buying the safe. Now, if the cost of insuring a pile of cash were in fact lower than keeping it in a bank account...*that* would be interesting.

Heading that way now.

"The insurance payments would effectively be negative interest, plus the fixed cost of buying the safe. "

The cost of leasing a safety deposit box at a high security bank is low. The question is the insurance. It should theoretically be very low assuming the insurance company can protect against fraud.

I'm not surprised, anyway. It's like all that investing marketing material that continues to try to convince you that you'll earn a 7% return based on history (starting from 1980). If they told you that 2% were more reasonable given present conditions, most prospective clients would just throw their hands up in disgust and not bother investing.

Recent conversation:
Me: "Don't invest [my German wife's] money in those managed funds. Keep it in cash."
Banker: "Doesn't she want to grow her savings?"
Me: "She absolutely wants to grow her savings. She doesn't think it's possible."
Banker: "Even with this evidence?"
Me: "The evidence doesn't say what you think. Start from 1998 and tell me what it says."
Banker: "...I'll keep it in cash."

In all likelihood, the S&P 500 will produce a return of 7% or more over the next 20 years.

S&P500 will be ~8100 in 20 years @ 7% annual growth.

Wonder how much college or a hamburger will cost relative to that.

Well by the same logic the rate of inflation will be roughly 3% per year.

If inflation is 2%, a hamburger will be 50% more expensive in 20 years. You will be able to buy a lot more hamburgers in 20 years than you will today if you put it your money in the S&P 500 in the meantime.

The S&P 500 first exceeded 200 in November of 1985. It's 10 times that level now (plus dividends in the meantime.) Are hamburgers 10 times as expensive as they were in 1985?

Brian, If you borrow at 2.5% and there is 2% inflation, how soon will you go out of business? Oh, you won't enter the business. Now do you understand.

Hard to find data in nominal numbers for a national average but one data point is from the University of Nebraska. (Do a search for "History of Undergraduate Per Credit Hour Tuition and Average Academic Year Cost with Fees")

Tuition and fees for a resident undergrad 1985-1986 was $1,513. For the 2015-2016 year it is $8,279, an increase of 547% compared to a ~1000% increase for the S&P from that time. If increasing by the same amount as the previous 20 years, a year of undergrad college tuition at UNL will be $45,286 in 2035-2036.

If you have a child today and want to save enough money to pay for his 4 year undergrad education you'll have to save and invest $428 a month (assuming 7% growth) in order to pay for the roughly $181,000 four year tuition cost. That does not include room and board or living expenses. That is roughly 10% of the current median household income before taxes.

Hamburger was $1.24 per lb in 1985 according to the BLS. Today is roughly $4.00, a nominal increase of 322%. It would be $12.88 in 20 years if it goes up another 322%.

Interestingly, the jump in price of tuition from 1967 to 1985 was similar to the jump from 1985 to 2003. Roughly 3.5x in 18 years. The trend from 2003 to 2021 seems to be slowing down. It is on pace to roughly double.

Hamburger is relatively more expensive today than it was in 1985 for the average household.

Median Household Income 1985: $23,618 (FRED)
Median Household Income 2014: $53,657 (FRED) (227% increase)

Hamburger has gone up 322% (BLS CPI) in that same time span.

If only we had all invested in the S&P500.


If you're the Bill I remember, I understand that lawyers and math are often an amusing combination.

Brian, I use math and stats a lot in what I do, and occasionally teach a part of a graduate course using math as well. Apparently you have a problem understanding the effects of deflation. Maybe you need to take a trip to Japan.

Bill, stop talking gibberish

Boomers will keep putting more money into the market when they retire because they can simply tell the banks "trust me, I'm good for the checks I'm writing because I'm writing checks to put money in the market as well as pay bills even though I no longer get a paycheck deposited to my account every other week."?

Or SS will go bankrupt because boomers will be taking more money out than workers put in, but the s&p500 will keep going up even if boomers are cashing out stocks faster than workers use their retirement savings to buy stocks?

Really? It's been an average of 3.6% per year since 1998. Why shouldn't I use that figure?

Because (a) your number doesn't include dividends, which add about 2% per year to the return, and (b) extrapolating from past performance is about the worst way of proceeding here.

The current earnings yield on the S&P 500 is north of 5%, and over the past 55 years, earnings growth has averaged more than 6% per year. It's unlikely that we repeat the past 55 years, when the S&P returned 11% per year on average, but 7% seems reasonably conservative.

So, let's not extrapolate from past performance.

Your statement becomes...
"The current earnings yield on the S&P 500 is north of 5%, and [extrapolation from past performance ignored] but 7% seems reasonably conservative."

Nope. Can't be substantiated.

Oh dear. Look, earnings at S&P 500 companies can go down, in which case the return would be less than 5%.

No one knows where earnings will go. That's the point of equity. After 55 years of earnings growth above 6%, I don't think it's much of a leap to assume earnings will increase in some fashion. Maybe it's 400 AD in Rome, but probably not.

This is nothing like the 18-year rear view mirror you are operating with.

"Your statement becomes… “The current earnings yield on the S&P 500 is north of 5%, and [extrapolation from past performance ignored] but 7% seems reasonably conservative.”"

Does it really matter if earnings are 5% in a 1% inflation period or they are 7% in a 3% inflation period? What are the real earnings historically? Aren't they pretty consistently around 4%?

In fact, cash in circulation has been exploding wherever interest rates and inflation approache zero, such as in Europe, Japan and the United States. Likely this will create a bifurcated economy, one underground and in cash, and the other more heavily taxed and aboveground economy.

In the U.S. there is about $4,500 in circulation for every resident. In Japan it is about $7,000 Yen equivalent.

I can't read FT articles so maybe this is covered in the piece, but are there banks where zero or negative nominal rates are no biggie?

Just sayin':

There is always the fiscal expansion alternative to negative interest rates.

"There is never a fiscal expansion alternative to negative interest rates."


Right, the option that exists does not in fact exist. We should come to Cliff for more advice. He will surely lead us in the right direction.

Just let me know when I can refinance my mortgage at a negative interest rate.

I believe some countries in Europe have these now, mortgages where the bank pays the homeowner. I think I heard about that in the Netherlands....

And my wife will get me a gift on her birthday!

Money is only free for the bank. For us peasants, we must pay.

The Eurozone is an optimal currency area. For some set of people.

Well, well, well, the Weimar State is in a tizzy because "usury" went negative :)

Who likes it? Plus, it's not working.

Search for 'Riester' (as in Riester Rente), find nothing, realize this is yet another one of those times where commenters have little knowledge of Germany.

Though the Munchhausen joke was at least amusing.

Admittedly one of these decades, Münchnau will be correct in something he predicts concerning eurozone dissolution.

Don't you want to play the expert and show your superiority?

OK the market rewards what it needs and punishes what it doesn't. Right now demand is low so those who are inclined to forgo consumption (i.e. savers) find the rewards are low or even negative. So what? When oil prices are low people who own oil wells find that their assets are a source of pain rather than pleasure?

And before you say it's the government keep in mind the central bank typically only sets the short term rates. If markets thought supply was being tapped out and inflation was coming then long term interest rates would rise...thereby solving the problem of savers.

Solution: Direct fiscal stimulation. Instead of printing money and giving it to savers hoping interest rates get so negative that they will finally start consuming, have the gov't spend the money directly and/or give it directly to spending inclined people.

I'm confused.

If NIRP is such a big deal for the germans and the germans hold sway over the ECB, why aren't they (ECB) doing more and more QE?

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