Reza Moghadam Flags 'Enabling Deep Negative Rates to Fight Recessions' in the Financial Times

I announced Ruchir Agarwal’s and my new IMF Working Paper in “Ruchir Agarwal and Miles Kimball—Enabling Deep Negative Rates to Fight Recessions: A Guide.” We are both delighted to see Reza Moghadam flag it in a Financial Times op-ed: “The ECB must make negative interest rate policy effective.”

Below, I quote the key passage from Reza’s op-ed, with my own section headings interspersed—headings that reflect what Ruchir and I call the various issues. After that, I repeat some Twitter exchanges I have had, prompted by Reza’s op-ed; these Twitter exchanges illustrate what Ruchir and I call “the political problem” and some of the ways Ruchir and I see for partially addressing the political problem. Here is Reza:

The Bank Profits Problem and the Paper Currency Problem

… with the ECB deposit rate already minus 0.4 per cent, the scope for meaningful cuts in interest rates seems limited. This credibility problem with interest rate policy requires the ECB to overcome two obstacles.

First, as it is, banks are not fully passing on the negative rate they pay on reserves at the ECB. Of course, banks can still make profits so long as their lending rates are above their borrowing costs. But while they have passed on negative rates to corporate depositors, they have not done so to households. No bank wants to undermine its funding base or be the first mover. Other things being equal, the result is lower bank profitability or higher lending rates, which weakens policy effectiveness.

Second, even if the above issue were resolved, there remains the risk of a flight to cash: as currency guarantees a zero rate of return, significantly negative deposit rates risk a large shift from deposits to cash — thus destabilising banking and economic activity.

If the ECB is to make negative rate policy truly effective, it will need to come to grips with both the transmission problem and the flight-to-cash problem. Fortunately, there are solutions, as recently discussed in an IMF paper by the economists Ruchir Agarwal and Miles Kimball.

Addressing the Bank Profits Problem

On the transmission problem, the ECB could shield small depositors from negative rates. For example, the ECB could ensure that, say, the first €5,000 of each depositor’s account is guaranteed a minimum deposit rate of zero.

The cost of such a subsidy, which ECB data suggest would fully compensate the bottom two-thirds of households by income, would be around €15bn for each percentage point of negative rates.

This seems manageable relative to the ECB’s profits and, more importantly, the goal of transmitting monetary policy to the broader economy. Such a policy can make negative rates more politically acceptable by protecting regular households, while limiting the negative impact on bank profitability. This would also be preferable to recent proposals for “tiered” ECB rates, which benefit a narrow group of banks.

Addressing the Paper Currency Problem

On the flight-to-cash risk, cash holding can be made costly. Specifically, the ECB could impose a transaction fee — equivalent to a negative interest rate — whenever a bank approaches it to obtain currency. Banks routinely turn to the ECB for currency when customers make unexpectedly large cash withdrawals at a branch or an ATM. Citing the fee, banks should be able to pass the cost on to the public. By varying the fee at its cash window, the ECB can operate the system at any negative rate it chooses.

The Political Problem

None of this is to play down the logistical and communications challenge in moving to deeply negative interest rates …