By Brian Kesten
The
Federal Reserve increased the federal funds rate for
the first time in nearly a decade this past December, raising the
target rate from 0-0.25% to 0.25-0.5%. Yet the Fed’s historic move to raise
rates is dwarfed in significance by the actions of the European Central Bank
(ECB), the Bank of Japan (BoJ), and the Swedish Riksbank: the unprecedented negative
interest rate
policy. This marks the first known monetary move below the zero lower bound, previously
thought to be the hard floor on interest rates.
In
effect, the central banks in Europe and Japan are charging fees for holding
required and excess reserves parked at the central bank by domestic financial
institutions. Austerity programs and fiscal deficit fears have stifled growth in
the Eurozone and Japan, so the central banks in these nations essentially bear
the mantle of stimulating economic growth, with fiscal spending and tax
reductions off the table. Before implementing negative interest rates, the ECB,
the BoJ, and the Riksbank engaged in quantitative easing programs, aimed at
flooding financial institutions with liquidity that the commercial banks could
invest in domestic industries in the form of business and home loans.
By
implementing negative interest rate targets now, the ECB, the BoJ and the
Riksbank banks hope to force banks to make loans or effectively pay a tax on
the inactive reserves generated through the central bank’s purchases through
quantitative easing. Negative interest rates are
not popular
with everyone, and some call the tactic a “dangerous
experiment.”
The
Fed had its own quantitative easing program from 2009 to 2014, which led to a $3.5
trillion dollar increase to the Fed’s balance sheet. Unlike its central bank
counterparts around the globe, the Fed moved to increase interest rates in
2015, despite low inflation and lagging
wage growth.
In fact, the most recent projections show that Federal Open Market Committee
members, which set the target federal funds rate, anticipate
increasing the rate by roughly one percent each year through 2018 before
flattening out at three or four percent.
Many
commentators questioned the Fed’s choice to increase rates, including Nobel
prize winning economist Joseph
Stiglitz,
former Treasury Secretary Lawrence
Summers,
IMF Managing Director Christine
Lagarde,
and China’s Finance Minister Lou
Jiwei.
The United States’ action to increase rates is out of step with the rest of the
world economy.
Proponents
believe that negative interest rates could jumpstart the U.S. economy by
pushing cash into the market. Since 2010, the U.S. money supply has skyrocketed to unprecedented
levels, which are mirrored in the mountain
of excess reserves held at the Fed earning interest. Negative
interest rates would incentivize financial institutions to put these funds to
use in the real economy, and could help meet the Fed’s underperforming
inflationary goals.
So,
could the Fed adopt negative interest rates, if the time came? Maybe not.
To
effect negative interest rates, the Fed can’t simply set the rate like a price
control. Instead, the Federal Open Market Committee (FOMC) acts to pull the
market in the desired direction through buying and selling treasury securities
and bank reserves. Unfortunately, buying and selling activities can’t pull the
federal funds rate into the negative. The Fed would need to effectively enforce
an industry-wide tax on bank deposits by charging financial institutions to
hold money at the Fed, who would then pass that cost on to depositors and other
institutions.
The
Fed might not have the necessary tools. In 2006, Congress passed the Financial
Services Regulatory Relief Act authorizing the Fed to pay interest on reserves
beginning in 2011, which the Emergency Economic Stabilization Act accelerated
to 2008. It is not clear if this authority to “pay
interest”
could also allow the Fed to charge interest in affecting a negative interest
rate.
In
fact, Fed Chair Janet Yellen expressed
some doubt about
the Fed’s power to do so on a recent hearing before the House Financial
Services Committee. This sentiment echoed
a 2010 memo
just released by the Fed, which considered the legality of negative interest
rates and the impact on the market for treasury securities. Additionally, the
global economy, and particularly the
presence of competing financial institutions, could obstruct the Fed’s ability
to implement negative rates.
If
the Fed does decide to impose negative rates one day, the cleanest path would
be to seek Congressional action authorizing the Fed to charge a tax on reserves
held at the Fed. Some scholars doubt the constitutionality
of
the FOMC altogether. Others have noted that the Fed has stretched its statutory
authority in the past to meet its objectives from trading in short
term bills
in the early 20th century, to trading in
foreign currency in the mid 20th century before it was legal, to
the controversial “Maiden
Lane”
bailouts of 2008.
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