The Federal Reserve raised interest rates, at 0.25% on December 16, for the first time in nine years. Key indicator to the unanimous decision is the low unemployment figure currently at 5%. Fed Chair Janet Yellen mentioned the lower oil prices and the fact that they only need to stabilize for that to stop putting further pressure on inflation. This was the first increase since the Fed pushed the key rate to 5.25% on June 29, 2006. The committee also took the rate to zero on December 16, 2008.
If the Fed has taken the rate to zero before, is it also possible that in the near future we’ll be having zero interest rates, considering that the market hasn’t been performing well since the start of 2016?
What Happened in Japan
Japan’s central bank, The Bank of Japan, announced a shocking decision on Jan. 29 where they are charging banks 0.1% for parking additional reserves with the BOJ. The move was made to encourage banks to lend, as well as prompt businesses and savers to spend and invest. It came into effect on Feb.16.
Since the BOJ’s board announcement, the Nikkei index dove to 8.5%. On the other hand, the yen climbed to 6.5% against the dollar. Economists say that Japanese households have little to gain from negative rates because about half their 1,600 trillion yen assets are in deposits. Also, their debt is much smaller compared to their Western counterparts.
For Japan’s banks, the move will trigger a long-term bleeding in their core business. They are not keen on the short-term crisis the negative rates will cause. A decline in interest rates squeezes interest-rate spreads thereby hitting profitability. Interest rate spread is the difference between what banks pay depositors and what they get from borrowers.
Katsuhito Sasajima, a Mitsubishi UFJ Morgan Stanley Securities analyst, says that the decision of Japan’s central bank is adding insult to injury. A Standard & Poor’s analysis also found that the BOJ’s move is likely to cost Japanese banks more than a few billion dollars in profit. Analysts at JP Morgan also say that so far, banks are unable or unwilling to pass negative deposit rates to their retail customers. By penalizing commercial lenders for parking their reserves at central banks, it takes away the profit margin they should be making by charging already low interest rates while raising the cost of capital.
Not only had Japan go this route. Sweden on Feb.11 lowered its bank lending rate to a negative 0.5% from a negative 0.35%.
The question now remains: does the world have any limits of what kind of monetary policy they can achieve, now with sub-zero rates looming in other central banks?
How About Negative Interest Rate Policy in the US?
It’s not clear that it would even be legal in the United States, although speculations about this possibility have risen last quarter of 2015.
“How is an NIRP supposed to help the economy”, you may ask.
If a central bank cuts rates, such move will motivate business investments and increase consumer spending. The move will also increase stock market value and other high-risk assets. Higher inflation rates in the future are also expected. It also lowers the value of a nation’s currency thereby making exporters more competitive.
So far, the Fed is expected to be in interest-raising mode with the labor market appearing to be in stronger shape. Although Fed Chair Janet Yellen doesn’t think that such policy can happen in the United States, she doesn’t even rule it out. There is still no certainty that the Fed will take this path as Yellen admits that it is not just a question of legal authority. It is also a question of whether the country’s institutional structure of the money markets is compatible with it.
I guess we’ll have to wait and see.