Central Bank With Negative Rates Record Shows Why They Work

Denmark’s central bank says its latest study into the long-term effects of negative interest rates shows the policy works better than is widely appreciated.

Morten Spange, chief monetary policy adviser at the bank in Copenhagen, says cutting rates below zero is an effective way to support lending.

That’s “an important result, if you are considering introducing negative rates in order to support the economy,” Spange said in an interview.

The policy remains controversial, and a number of central bankers reject it as an extreme to avoid. Denmark uses it to defend a currency peg. But Sweden abandoned the policy in December, and it’s viewed with skepticism in the U.S. In the U.K., policy makers are now exploring the idea as a way to help fight the fallout from both Brexit and the pandemic.

Denmark’s eight-year stint with the policy is the longest in the world, giving it a unique perspective. It first resorted to negative rates in mid-2012, when investors were searching for safe places to put their money during Europe’s debt crisis.

Natural Laws

Spange says the laws of monetary policy don’t change just because rates drop below zero. “What we have discovered is that negative interest rates are in some sense a natural extension of very low but positive rates.”

Some of the pass-through effect occurs with a lag, when rates drop below zero. Danish banks waited about seven years before daring to send negative rates on to their retail depositors. So far, there’s no evidence that Danes are hoarding cash.

Jesper Berg, the head of the Financial Supervisory Authority in Copenhagen, says negative rates have had “a huge impact” on banks’ business model.

The central bank’s study, published on Thursday, shows that when banks introduced negative deposit rates to corporate accounts, firms increased investment and employment to a statistically significant degree. They also lowered their debt and liquidity levels.

But businesses initially tried to avoid negative rates, and shopped around for banks that hadn’t yet introduced them, the study found.

No ‘Reversal Rate’

The analysis is the latest in a series by the central bank. Overall, researchers “don’t see any restriction in credit,” Spange said. “And we don’t see what some studies have called the reversal rate, where negative rates start becoming contractionary for the economy.”

Read More: ECB Study on Reversal Rate Fuels Skepticism on Further Cuts

In Denmark, roughly 80% of businesses and a growing number of retail depositors now face negative rates. Danske Bank A/S, Denmark’s largest bank, recently announced it will charge all retail depositors with over $40,000 sitting on their accounts.

“If the whole market is going that direction, at some stage it becomes very difficult not to take that step,” Chief Executive Officer Chris Vogelzang said. “We don’t see negative interest rates disappearing very soon, so at some stage you have to bite the bullet.”

Spange says a wave of financial regulation has been key in preventing the kind of dangerous imbalances that might otherwise have stemmed from negative rates. But he also says there may yet be risks that will become clearer over time.

“You always have to be concerned. We are in uncharted territory with negative rates, and risks are often building up where you’re not really watching,” he said. “So it’s important that we are always vigilant.”

©2020 Bloomberg L.P.

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