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In response to the ongoing coronavirus pandemic, the Bank of England has cut base rates of interest to an all-time low of just 0.1%. This is down further from its initial emergency cut from 0.75% to 0.25%, made only one week prior. Officials are stretching the limits of conventional monetary policy to avoid another major economic downturn. With base rates now at almost zero, could the Bank be about to make a more controversial step and introduce negative base interest rates for the first time in history?  

Negative interest rates work in the opposite way to traditional interest rates, meaning that those who deposit into accounts must pay money to the bank to store their cash, rather than receiving money themselves. In effect, borrowers get paid to borrow. This ‘use it or lose it’ approach for lenders is used to discourage saving and encourage spending, to try stimulate the economy. When central banks do it, it is designed to incentivise commercial banks to lend more freely. This upside down way of banking has been flirted with in some radical circles, but this has caused unease among many.

Negative interest rates worry some policymakers because they fear significant distortions in the market. The Bank of International Settlements has warned of “eroding incentives for the private sector to maintain adequate buffers against financial stress”. Moreover, negative rates disincentive sensible saving practices by effectively penalising savers and could have unforeseen consequences for the operations of pension funds, risking leaving swathes of the population out of pocket.  

There is also the simple uncertainty of uncharted waters. Modern economies are so complex that analysing risk outside of the usual frameworks becomes a major challenge. When the normal rules break down, the models which economists have relied on to assess trends and outcomes begin to lose their potency. Why, then, have negative interest rates continued to grab headlines?

The context in which some central banks have been tempted to use negative rates is one in which the usual monetary levers have been exhausted. In the wake of the global financial crash, central banks slashed rates. Indeed, figures from last year showed that central banks have cut rates more than 800 times since the start of the Great Recession. This cutting to lower and lower rates has meant that many central banks haven’t been left with much traditional room for maneuver. As global growth has remained sluggish, some believe that the only recourse left is to go negative.  

In February 2015, Sweden’s central bank was the first in the world to implement a negative main repurchase rate, launching a historic experiment in monetary policy. The Riksbank, which is the world’s oldest central bank, lowered its rates from 0.25% to -0.10%. The move was controversial, but was coupled with a mass purchase of Swedish government bonds as part of a desperate effort to pump money into the Swedish economy and avert deflation.

Five years later, the experiment has concluded. It is too early to properly assess the ramifications of the experiment, though there are fears that the consequences for the behaviour of economic actors could be perverse and damaging in the long term. Although the Swedish economy is relatively small, the experiment has attracted the fascination of policymakers. For now, the Riksbank has returned its main repo rate to zero, so not back into genuine ‘positive’ territory yet. 

While he was still Governor of the Bank of England, Mark Carney said only last year that he opposes negative interest rates, claiming that they are “not an option” for the UK. He instead emphasised a commitment to the traditional approach of keeping rates as low to zero as possible, but without drifting into negative rates. Last month, just as the coronavirus was only beginning to emerge as a potential global challenge, he nevertheless confessed that we are “close to those limits” of what conventional policy can achieve. 

The new Governor, Andrew Bailey, is experiencing a baptism of fire with collapsing markets and very few weapons left in the traditional arsenal. Thrust into the top job during this most unprecedented of crises, he must carefully nurse the economy back to vitality. He has been described as a “safe pair of hands” rather than a radical. Bailey has insisted that no policy has been ruled out, but is said to be resistant to negative rates. As this crisis deepens, and perhaps becomes more protracted, however, it is possible that the Bank will reassess the limits of its radicalism.

Joseph Silke is Research and Communications Assistant at Bright Blue.