The European Central Bank (ECB) took the unprecedented step Thursday by imposing a negative interest rate on banks for their deposits—in effect charging lenders to park money with it.
The move was part of a series of measures to combat the euro zone’s growth-sapping disinflation and give a push to its stuttering economic recovery.
Business Insider announced ‘The Era Of Negative Interest Rates Has Begun’ and noted:
Specifically, the ECB cut the deposit rate to -0.1%, from 0.0%, effective June 11.
This is a historic development, as it’s the first time a major central bank has cut any main interest rate to negative in a bid to spur lending and spending.
The idea is that if banks aren’t being rewarded with a good deposit rate by parking their reserves at the central bank, then they will be more likely to lend it to households and businesses.
This development, while perhaps something new in a de jure kind of way, is really not a significant change in the de facto status quo in which central banks, most notably the ECB and the Fed, are continually seeking to jumpstart economies by inflating the money supply. Of course, they’ve been trying to jumpstart things for nearly six years, but surely this latest move will work like a charm.
By switching to negative interest rates, the ECB is hoping that more money will move out of banks’ reserves and into the “real” economy in the form of loans and spur growth. It’s more likely to spur inflation and unemployment, however. The idea is that if negative interest rates force banks to reduce reserves and loan more, then people and firms will borrow more, spend more, and create a demand-induced boom. Unfortunately, it doesn’t really work that way. We might also note that one reason that inflation, at least in the US, has been muted is the huge stack of excess reserves banks have accumulated. (See here for more on that.) Negative interest rates here in the US could get those funds flowing, with inflation to follow.
And finally, to be fair to the ECB, no one can claim that it hasn’t done its part to flood the economy with liquidity when we consider the growth in central bank assets in recent years: