A year ago, Sweden’s Risksbank, the oldest central bank in the world, became the first major monetary bank to move its core interest rate into sub-zero territory in an attempt to stimulate the Swedish economy. Since that time, there have been three successive drops in their rate, even further below zero. This represents a new paradigm shift in the philosophy of the bounds central bankers have in setting interest rates.
It was believed that the lowest limit for a central bank to set their overnight rate was at zero. Who would chose to leave their money in the bank if they had to pay for the privilege of doing so? It used to be thought that decreasing central bank interest rates would boost an economy. Savings rates would naturally drop and people would choose to spend more money and save less.
Some economists warn that there is a limit to the economic benefits of stimulus from cutting rates. This is called the “zero lower bound”. If rates go too low, savers face negative returns, and this will encourage people to withdraw their savings and hoard cash. This act will slow, rather than grow the economy.
Sweden is an interesting example. It has the third highest savings rate in the developed world. Instead of touching off a mass of economic growth with the rate cuts, expansion is slow. The unemployment rate still above 7%, still well above the pre-crisis levels of 5%. Sweden is actually experiencing deflation which is well below the central bank’s target inflation rate of 2%. As the economy of other countries has weakened, the cost of importing goods into Sweden has fallen.
The central bankers in Sweden have been joined by all countries in the Eurozone, several in Eastern Europe, and now, Japan. The Japanese shocked the world with its decision to go sub-zero last month in an attempt to drive down the value of its currency. Since the interest rate drop, the Japanese Yen has actually risen by 9%.
Currently, over $8 trillion of sovereign debt is trading at a negative yield. For those not in the negative yet, many countries are flirting with it. Banks have also not been willing to pass on the negative deposit rates to their customers. This increase in the banks’ cost will force them to make up the revenue somewhere else, such as higher lending costs or more fees. Higher lending costs will have a counter effect to the goal of the central bankers’ of economic stimulus.
This leads a vicious cycle of slow or negative economic growth followed by the attempt by central bankers to devalue their currency, do a round of quantitative easing, or push rates into negative territory to stimulate the economy. The economy does not improve and more money is parked on the sidelines as businesses and individuals believe the future is not bright. This can lead the central bankers to do another round of stimulus.
Eight years have passed since the financial crisis. Central banks around the world have cut core interest rates 637 times and injected another $12.3 trillion into the system. Yet, the current global recovery is one of the most deflationary in modern times with growth rates averaging 1.6% over the past six years. It appears that rate of growth may be optimistic in the present world with a dangerous cocktail of low commodity prices, stagnant demand, and skyrocketing sovereign debt. It also makes one wonder if the central bankers really have any grasp on what is going on to begin with.