I'll be happy to borrow money from you... if you pay me.

Recently, in the New York Times Upshot, Neil Irwin discusses the issue of the recent strategy by central banks such as the European Central Bank (ECU) to charge negative interest rates (currently -0.3% for the ECU).  This is a novel strategy for central banks and even the Federal Reserve is looking at it.

From a monetary policy view, this is simply charging interest to banks for keeping funds (excess reserves) on deposit, rather than paying them interest.  The idea is to incentivize banks to lend the money out rather than holding excess reserves.  The graph below shows recent history of excess reserves.

Up until 2008, excess reserves were very small.  From 1990 to 1996, excess reserves averaged about 4.64%.  Between 1997 and August 2008, the percent rose to an average of 16.97%.  However, from September 2008 to January 2016, the percent of excess to total reserves grew to an average of 97.87%.  Bank reserves are broken into required reserves and excess reserves.  For the layperson, required reserves are funds banks are required to hold to cover deposits.  If the Federal Reserve pursues an easy money policy (increasing the money supply) then it buys treasury securities and deposits the proceeds in bank reserve accounts.  Banks normally have an incentive to lend out those reserves leading to an increase in the money supply and stimulating the economy.

However, the situation changed due to factors such as the financial crisis.  This is part of the reason Quantitative Easing had limited effect.  Another reason is since October 2008, the Federal Reserve banks pay interest (currently 0.5%) on reserves, both required reserves and excess reserves.

If the Fed were to now start charging interest on excess reserves, we would expect banks to be incentivized to use those funds to make loans.  However, banks may decide to make more loans, but would there be more borrowers?  Consider the fact that corporations are sitting on cash, estimated at over $1.5 trillion.  There are many reasons for thesecash holdings including some of the cash being from foreign income and the unwillingness of firms to repatriate it for tax reasons.  However, as noted in an article in the Regional Economist, a working paper by Lee Pinkowitz, René Stulz and Rohan Williamson challenges the tax reason.  As a result, firms may have little incentive to borrow.  For consumers, the prospects may be better, but households have spent years reducing their debt burden.  Here is a graph from the FRB FEDS Notes showing the ratio of household debt to Personal Disposable Income (DPI).

While the ratio of household debt to DPI has been declining, it remains significantly above historical averages.  Households may be reluctant to increase borrowings since they have been saving more to return to more sustainable debt-to-DPI ratios.  This means households will likely continue to save more even if they pay for it.  So given the current household situation, negative interest rates may have a minimal effect on driving consumer economic stimulus.

The decision by European central banks to lower bank lending rates to negative levels reflects the continued economic malaise they face.  While the US seems in better shape, we are not immune and part of our slow growth in in part the European situation.  We now have a live experiment as to what the effects of negative nominal interest rates will have.  My hypothesis is that negative interest rates will not help much.