Negative rates will do more harm than good for the UK economy

Linda J. Dodson

But the Governor will be cautious before sinking his own fangs into UK savers, as there are so many good reasons not to do it. Threadneedle Street will be desperate to buy itself more time and stretch out a review – which according to chief economist Andy Haldane is due “well into” the second half of this year – before sliding down the rabbit-hole.

To start with, there is the issue of how low you can go: what economists call the “reversal rate”. At what point do people and companies simply remove cash from banks, buy safes and build themselves giant sheds for banknotes?

When I interviewed Monetary Policy Committee member Gertjan Vlieghe on the subject in 2016 he said that rate could be around -0.75pc, but his main point was that he didn’t want to find out: it was “almost certainly negative for the economy because then you undermine the whole bank funding model”.

Given that rates are already at just 0.1pc, if Vlieghe is right, the MPC does not have much more room to cut anyway against the greater risks to the banking system. Is it worth it?  It is easy (and often accurate) to slam the banks, particularly for their early efforts on Covid-19 support loans.

But the one thing we will need to help us out of the economic abyss left by the pandemic is a fully-functioning financial system. Our banks are far better capitalised than they were in 2007-8, which will support lending.

So it seems unwise to throw against that a systemic risk as well as a squeeze on profits which has sparked regular complaints in Switzerland, for example, as well as throwing up odd behavioural quirks. The Swiss are the outliers on negative rates, which have stood at -0.75pc since 2015.

The evidence on whether they actually work is also mixed. An ECB study found that companies with big deposits which made switching to cash less practical were more likely to be charged, and spend more on fixed assets, as per the theory.

But research into Sweden’s recently-ended experiment also found that banks were less likely to pass on the negative rates over time. From a behavioural economics perspective, the focus turned to preserving cash rather than embracing risk – classic loss aversion – when interest rates were negative rather than zero.

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