We’re hearing more and more about the idea that major central banks could turn their deposit rates negative in an effort to stimulate their economies. The European Central Bank is reportedly considering such a move, and officials at the Federal Reserve keep bringing up the idea.
So, what’s a negative deposit rate anyway?
To get a sense of it, you start with the more common phenomenon: A positive deposit rate. This is a policy tool whereby banks can park their reserves with central banks and in return pick up a small amount of interest. The ECB, for example, pays out 0.1% and the Fed pays out 0.25%. It’s kind of like a low-yield savings account for the banks.
The Fed introduced its rate in 2008 to help calm short-term interest rates during the financial crisis. Since then, banks have put $2.3 trillion worth of reserves into the system, according to Reuters. By depositing money with the Fed, they earn well more than they would using the fed funds rate, the rate at which banks lend to each other overnight.
Changing the deposit rate serves as one tool central banks can use to influence how banks spend their reserves. If banks can earn a healthy return depositing reserves at a central bank, they are likely to do so. But if they can’t, they’re likely to deploy their cash elsewhere, such as by lending to households and businesses, which would benefit the broader economy. So by making the deposit rate negative, the central bank is trying dissuade these risk-averse banks from locking up their cash.
The ECB is reportedly considering lowering its deposit rate from 0.1% to negative 0.1%, according to Bloomberg, which cited anonymous sources. That means banks would have to pay the ECB to lend to it overnight, an unprecedented move for the bank (which sent the euro weaker Wednesday). Such a move would make it less attractive for banks to park their reserves at the ECB.
“Clearly the signal it sends to me is that the ECB is serious about trying to kickstart the economy and get financial institutions to do something with money besides leaving it sitting with the central bank and earning some small interest rate,” said Jim Sarni, managing principal at Payden & Rygel.
The ECB isn’t the first to make that move. In 2009, Sweden turned its deposit rate negative and it seems to have posed no threats to the financial system thus far.
Nonetheless, the Fed hasn’t taken such actions stateside, leaving its interest on excess reserves, or IOER, unchanged at 0.25%. When Janet Yellen testified before the Senate Banking Committee last week, she left open the possibility that the Fed could cut its rate, though she noted concern about how that would disrupt the short-term money markets that utilize the rate.
St. Louis Fed President James Bullard, however, said in remarks Wednesday that the Fed should study the impact of turning the rate negative.
Despite the fact that the ECB appears to be closer to turning its rate negative, others remain skeptical that the Fed will take such an action.
“In principle, a reduction in the IOER should foster economic activity by removing one key disincentive for banks to lend,” said Millan Mulraine, director of U.S. research and strategy at TD Securities, in a note last week. “However, the experience of the ECB (which reduced their IOER rate to zero) and the Swedish central bank (which began charging banks 20bp for holding excess reserves) in 2012 have failed to support this view.”
– Ben Eisen
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