Negative interest rate a poison
More and more countries around the world are experimenting with unconventional monetary means - first a zero interest rate, then a quantitative easing program of flooding financial institutions with capital, and now negative interest rates. In a negative-interest-rate environment, deposits require fees rather than paying interest. In theory, this encourages companies to invest and consumers to spend instead of leaving money in bank accounts. It is the last resort for monetary authorities as their economies remain stubbornly stagnant no matter how much they print money and make it cheaper for banks to lend.
Five countries have now pushed their interest rates into negative territory. The move has several major intentions. For Denmark, Switzerland and Sweden, it was aimed to curtail the upward spiral in their currency value. Meanwhile, the eurozone and Japan turned to negative interest rates to boost their economies and fight deflation, as all other extreme actions of zero interest rate, expansive bond-purchase programs and fiscal spending fell way short of kicking their economies out of stagnant deflationary danger.
But the drastic measure of negative interest rates has so far missed their target and are instead generating various side effects. Denmark and Sweden helped bring down their currency value to some extent, but at a high price. Real estate prices in Sweden shot up 25 percent, and household debt jumped 7 percent in 2015. In some areas in Denmark, apartment prices jumped up to 60 percent compared with 2012 levels. Despite negative interest, monetary supply fails to translate into corporate or consumer spending in the eurozone. In Japan, which lately joined the negative-interest-rate club, stock prices came crashing down over concerns about the economy while the yen soared. It is an ominous sign that financial markets move differently than anticipated.
The effect on the global financial market has been serious. The divergence in the capital market aggravated volatility due to the opposing monetary direction of major economies, with the United States in a tightening cycle and the eurozone and Japan pumping more liquidity through negative interest rates. The flood of loose liquidity is sweeping across stock and bond markets of emerging economies.
A negative interest rate itself is innately potentially dangerous. Imposing fees for deposits can trigger a rush of withdrawals or a bank run and take a toll on profitability in the banking sector. Banks would have to reduce corporate and household loans or be tempted to make risky investments. If money is blood, financial institutions are the blood vessel. What was aimed to pump up the blood supply could actually end up contracting the vessels.
Still, the central banks of major economies are more and more drawn to the idea. The European Central Bank plans to push interest rates further down in the negative in its March 10 policy meeting, and the Bank of Japan is expected to take similar action in its meeting five days later. The U.S. Federal Reserve is also expected to discuss the option on March 16. The bizarre idea is becoming the norm, adding to global market volatility.
The Bank of Korea is also being pressured to bring down the base rate from the current record low of 1.5 percent to keep in tune with the trend in the advanced category. But we cannot afford to disregard the side effects of an ultra-loose or negative-interest-rate policy.
A cut now, when markets are heavily volatile, can bring more harm than good. Without the interest premium, foreign capital would rush out. A spike in the exchange rate could hurt the economy. Household debt could balloon, further dampening consumption and delaying corporate restructuring. When financial markets are unstable, cheaper rates would help little to boost investment and consumption. The rate cuts in 2014-15 aided the construction sector because cheaper rates were coupled with housing market stimulus measures. But the same effect cannot be expected from a rate cut now, as the housing market is weighed down by oversupply concerns and tough mortgage-backed loan review.
Authorities should stave off the temptation of resorting to interest rates to stimulate the economy. Instead, they should place top priority in stabilizing the financial market and revitalizing the economy. As the economy is in limbo due to poor effective demand, actions should be focused on stimulating demand. Regulations must be removed and incentives increased to encourage companies to invest and boost income for households. Locals and foreign tourists should be encouraged to spend. Export competitiveness must be honed and new markets and products explored. At the same time, the foreign currency safety net must be toughened so that the economy remains intact regardless of any external shock.
Translation by the Korea JoongAng Daily staff.
JoongAng Ilbo, March 2, Page 29
The author is head of economic trend analysis at Hyundai Economic Research Institute.
by Lee Joon-hyup