Six years after the European Central Bank cut interest rates below zero per cent, behavioural finance gurus have a message for other central banks thinking about taking the plunge: don’t.
Rates in the United States, Britain, Norway, Australia, New Zealand, Israel and Canada are at or below 0.25 per cent, so chances are one or more of their central banks will go subzero to try to counter the pandemic-fuelled economic funk.
Money markets are pricing in the Bank of England making the move in 2021 while New Zealand’s central bank has already asked banks to prepare for negative rates.
New studies however seem to reinforce what some policymakers have long feared – negative rates are ineffectual and perhaps even counterproductive.
“If your goal is to motivate people to take on more leverage [debt] and to increase investments in risky assets, then zero interest rates are actually more efficient than negative rates,” said Lior David-Pur, head of Israel’s state debt management unit.
Mr. David-Pur co-authored a paper published last month in the Journal of Behavioral and Experimental Economics, which found the highest positive impact on risk-taking and borrowing behaviour was achieved when rates fell from 1 per cent to zero per cent.
That is more or less in line with cuts made by central banks from the United States to Australia this year.
The study, a rare look into consumer reactions to negative rates, tracked the investment decisions of 205 university students studying economics who were divided into four groups, each with 10,000 Israeli shekels ($3,852) to allocate between risk-free bank deposits and risky assets such as stocks.
Interest rates ranged from 2 per cent to minus 1 per cent but were then cut by one percentage point. Participants were then asked how much more money, if any, they wanted to borrow to invest.
Mr. David-Pur said the group for which rates fell to minus 1 per cent, actually cut leverage by 1.75 per cent. But willingness to borrow rose by 20 per cent in the group that saw rates fall to zero per cent.
“The number zero per cent itself had special meaning for people,” Mr. David-Pur said, saying that once rates go negative, leverage – borrowing to invest – falls.
That’s because negative rates can suggest “some kind of emergency situation,” said Anatoli Annenkov, a former ECB economist who now works at Société Générale.
“That per se suggests that you won’t get the impact you want because people might just save more money instead of spending.”
Indeed, savings rates across the euro zone dipped briefly after 2014, then continued to rise as official rates fell further below zero per cent.
BEEN THERE, DONE THAT
Detractors have long noted that neither inflation nor growth have rebounded in the euro area and Japan after years of negative rates.
Fredrik N G Andersson, associate professor at the Lund School of Economics and Management, said the cost of negative rates for Sweden’s economy likely outweighed the benefits.
Sweden last year lifted its main rate back to zero per cent.
Prof. Andersson, who has researched the subject in detail, said borrowing did rise when rates were negative but money ended up invested mostly in housing, inflating property markets and household debt.
“It’s not like you borrow and you buy a car or something that adds to GDP. When you borrow to buy housing, you don’t get that stimulus effect,” he said.
Business owners had held off investing, he added, echoing Mr. Annenkov’s view that the negative rates had been seen as a sign of crisis.
Another experiment at Germany’s University of Muenster found the risk-taking behaviour of more than 300 volunteer “investors” was likely to change if they saw risk-free rates turn negative, for example on bank deposits.
While banks in negative-rate economies rarely charge depositors, Muenster University associate professor Hannes Mohrschladt said that could happen if the ECB cuts rates further.
But he warned the ECB should beware of rate cuts that “might increase prices in stock and real estate markets even further.”
Prof. Andersson said evidence suggests central banks do not need negative rates to spur growth.
“I would say don’t do it. It’s not worth it.”
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