By Steve Goldstein, MarketWatch
It’s not unprecedented for a central bank to bring interest rates below zero, but in separate comments at a conference in London, two officials at the Federal Reserve and the Bank of England said they were opposed to doing so.
The comments come at a critical juncture where the global economy is seen at risk of falling into a recession, with the International Monetary Fund on Tuesday saying the economy would grow at the weakest rate since the recession. The yield on the 10-year Treasury /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +1.00% has fallen from about 3.2% in November to 1.75%, a signal of the market’s concern with the state of the economy.
James Bullard, president of the St. Louis Fed, told reporters at a conference on monetary and financial policy why he didn't see negative rates as an option even during a recession.
“I’m not a fan of this type of policy,” said Bullard, who is one of the more dovish members of the Fed and argued for a half-point rate cut in September. “I think that negative rates have only had mixed results where they’ve been tried, and I also think that the U.S. short-term financing markets has differences from other markets and other economies.”
Bullard said it’s not clear, for instance, how the money market would adapt.
Gertjan Vlieghe, a member of the Bank of England’s monetary policy committee, answered an audience question about why the U.K. central bank doesn’t believe interest rates can drop below 0.1%. The current Bank of England base rate is 0.75%.
“The lower bound is not only about switching to cash. There is this important element of bank profitability in the financial system,” he said.
Another issue is the types of assets on the balance sheets of each country’s institutions, and whether they are indexed to the policy interest rate, he said. “And so to me it is absolutely no surprise that different central banks and different economic areas come to a different conclusion about how low that is.”
Vlieghe also explained the challenges involved in adopting so-called helicopter money, which refers to central bank financing of government spending. He said helicopter money where the central bank pays interest on reserves ends up being no different than a fiscal expansion.
“It is not that this would make it ineffective, it is just that it makes it little different from debt-financed fiscal expansion, other than unnecessarily making the central bank more involved in fiscal policy,” he said. If the central bank doesn’t pay interest on reserves, it would then push interest rates to zero — essentially suspending the policy instrument of the central bank.
“If there is a credible commitment to pay no interest on reserves, the central bank would have no control over whether reserve market balance is restored via a lot of inflation and a little real growth, or the other way around,” Vlieghe said.
“As a policy intervention in order to push up inflation, I think there is a good chance it would work! The problem is, with no instrument, no target, and no independent central bank, it might create much more inflation than is desirable, and there would be a period of uncertain length during which monetary policy would be unable to control inflation.”