Negative interest rates: A cure for the coronavirus recession?
We are in the age of the coronavirus, the perfect storm that will reign terror on our fragile economy. Quarantines prevent people from going to work, disrupting supply chains and shocking productivity. Fear of catching the virus alongside the push for social distancing slashes aggregate demand as money circulated through restaurants, shopping centers, and the entire travel industry is curtailed. This comes alongside upward inflationary pressures from a limited supply of labor and production.
A frightening word comes to mind: stagflation.
Which brought us to Sunday March 15, when the Federal Reserve enacted sweeping measures to increase the money supply and launch us out of impending recession. They cut interest rates to “near-zero,” elected to buy “at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed debt,” and eliminated bank required reserves so “they can continue lending.”
While this seems to be a step in the right direction, the concern now is “the Fed now has little room should things worsen.” After three cuts to interest rates in 2019, a half a percentage point cut in an emergency meeting on March 3, and the most recent extreme measures, The Fed may have exhausted all of their resources. Or not.
What if the Fed pushed interest rates below zero? After all, European countries have recently experimented with the idea of negative interest rates. At the World Economic Forum in January, President Trump announced it is “something [he] could get used to very quickly,” and he “loves” the idea.” Miles Kimball, Professor at the University of Colorado Boulder, has been a long time proponent of negative interest rates during serious recessions. He explains that in times of economic peril, negative interest rates “motivate those who would otherwise sit on that cash to take the risks to put it to use to build up the economy.” Those who want to save can still do it if they are willing to pay for it, but risk-takers would be rewarded.
The precedent for the real effects of negative interest rates can be taken from Denmark. Last August, Denmark’s Jyske Bank “began offering a 10-year fixed-rate mortgage at negative 0.5%.” and Finland based Nordea bank offered a 20-year-fixed-rate mortgage that charged no interest. Borrowers still have to pay back monthly payments towards their principle, but what they ultimately return is less than what they took out.
The idea does not go without concern, especially because it is new and has never been implemented in the United States. Danielle Hale, the chief economist at Realtor.com, voiced her concern that “Bank customers could turn to more risky methods of stashing money, such as holding onto actual cash or putting it into riskier investments.” Her concern is valid. What is to stop people from storing their paper money under the mattress, or in a vault, where it has an effective interest rate of zero?
Professor Kimball’s solution is to “demote paper currency from its role as a yardstick for prices and other economic values—what economists call the ‘unit of account’ function of money.” If prices are set in terms of electronic dollars, with paper money exchanged at a discount, then the Fed could set any interest rate on the electronic money, positive or negative. The idea does not seem so extreme when considering the amount of money circulating through the economy electronically through debit and credit cards already.
The recession has struck our economy: the unemployment catapulted to 14.7 percent last month as 20.5 million jobs, across all industries, were lost. While many businesses allow employees to work from home, jobs in construction, retail, manufacturing, leisure, etc… do not allow the same opportunity However, lockdowns cannot last forever and the economy has already begun to gradually open up in some parts of the United States. Businesses will need encouragement to begin investing again and with the Fed’s resources drained, negative interest rates may be our only hope.
Yonah Goldberg lives in West Hartford.
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