Interest rates in many countries around the world are still languishing at near-zero levels since the last financial crash. Which doesn’t leave much space to move in the event of, say, the next financial crash. At least as far as cash is concerned. So the Intentional Monetary Fund (IMF) have been looking at solutions to make negative interest rates a viable option.
Less Than Zero
Recessions require tough measures, which has historically resulted in around 3-6 percent cut from interest base rates. But with many nations still maintaining near-zero rates from the last financial crisis, that doesn’t leave them much wiggle room.
The problem, of course, is cash, which has a lower-bound interest rate of zero by design. A negative base rate would necessitate commercial banks to either compress their margins or charge interest on deposits. And charging negative interest on deposits would likely cause a mass withdrawal of cash.
The IMF notes that:
…instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.
So why don’t we just get rid of cash?
A cashless society would not be limited by a lower bound on interest rates of zero percent. Central banks could reduce the rate to a negative figure, forcing consumers to pay interest on deposits. This would encourage investing or simply spending money as a preferable option, boosting the economy.
But if cash exists then this cannot happen. People would simply hold cash at zero percent interest rather than paying for bank deposits in safes and mattresses.
Interestingly, countries such as largely-cashless Sweden have already pushed rates slightly below zero. The inconvenience and expense of taking out and holding large amounts of cash has deterred most depositors from doing so.
But cash still plays a significant role for payments in many countries such as Japan, Switzerland and Hungary. People kinda like the ‘P2p’ (person-to-person) nature of it.
The solution proposed by the IMF would be to enact a divorce between cash and electronic money, creating two separate currencies. In doing this, a central bank could make cash as costly as a bank deposit with a negative interest rate.
Sounds great, doesn’t it? How can we make cash more costly? But it’s all to maintain the inflation target at all costs, according to the IMF. An excerpt reads: