This Week's Focus: Negative Interest Rates. A good measure?

This Week's Focus: Negative Interest Rates. A good measure?

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The Bank of Japan joined the fashion of negative interest rates along the lines of the central banks of Switzerland, Sweden, Denmark and recently the Eurozone. As a result, deposits of commercial banks are penalized in their respective central bank reserves. The measure aims to encourage banks to lend more money to households and companies, increasing investment and consumption and away from deflation, but what is effective?

Increasing bank reserves

The banking business is mainly in lending money to an interest rate higher than that customer deposits are remunerated. Upcoming official rates have pursued improve financing conditions for borrowers. However, banks in general have tended to accumulate the money they get from credit facilities of central banks since the financial crisis of 2008, due to the increased demands arising from the solvency rules (Basel III central banks ) and the fall in demand for final credit.

Almost a quarter of the world's GDP originates in countries with negative official interest rates, as stated by The Economist. The negative deposit rate set by the central bank acts as a ceiling for interest rates in the short term money markets and interest rates of variable rate loans, as many mortgages indexed to Euribor.

Is there a limit?

Haruhiko Kuroda, the governor of the Bank of Japan said that there is no limit on measures to ease monetary policy. On interest rates, at least, that's wrong. The limit can not be zero, but it still exists.

The tendency of economists to believe that, with negative interest rates, banks and savers withdraw their deposits and maintain the cash has not been demonstrated so far. In Europe, where rates have been negative for over a year, they have remained stable.

For commercial banks, charge negative interest on deposits has proved bearable compared to the cost of securely storing piles of cash. For now, they have not moved this cost deposits of individual customers, but they could not take in doing so.

This certainly will lead to a contraction in bank profits, particularly in the euro area, where the ECB sets an interest rate of 0.3% to almost all reserves of commercial banks.

An alternative are safe and liquid government bonds, but yields have also become negative, even in periods of up to ten years in Switzerland.

In any case, may that negative interest rates, and create a distortion in the rational process of asset allocation, end up generating more problems than solutions. Some less profitable banks, subject to stricter solvency criteria, may end up giving less credit contributing to a slowdown in the economy instead of the intended expansionary effect. In addition, the slowdown in consumption and investment result of lower bank lending could exacerbate the problem of deflation.

When with low interest rates credit is not growing, it is likely that the reasons have to do with other factors not only the financial cost. Maybe you have to wonder if wages, employment expectations, the process of deleveraging post-credit crisis, uncertainty over geopolitical factors and demographics have to do with it.