Negative Interest rates

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Negative Interest rates

posted on Mar 30, 2016 01:38PM

Excerpts from a Financial Post article by George Bragues from Guelph-Humber University. We had a thread here a while back:

This is momentous. Yet all that most observers appear to be worried about is whether negative interest rates will work to invigorate sluggish economies. Something more profoundly disturbing is taking place. The way that people inherently confront the future is being tampered with.

We have come to this pass because central bank officials and mainstream economists misunderstand the nature of interest rates. Following John Maynard Keynes, the prevailing assumption is that interest rates are a purely monetary affair. In this view, the interest rate is a price determined by people’s desire to hold cash and the supply of money. Central banks cannot directly change people’s desire to hold cash, but they can indirectly affect it by using the power they have to adjust the money supply and interest rates. By lowering rates, a central bank can reduce the number of those willing to hold cash or its equivalent in terms of liquidity. Earning less interest on their bank accounts and money- market instruments, individuals and firms will be pushed to deploy their cash elsewhere.

Suppose that, on average, entrepreneurs and companies can expect to reap 10 per cent annually by embarking on a new line of business. Suppose, too, that the prevailing interest rate is two per cent. The result will be a lineup at the bank to borrow funds. As the bidding for credit rises, interest rates will tend to approximate the prospective rates of return on capital investments.

Another factor that influences interest rates involves people’s willingness to supply funds in the form of savings that others can then borrow. Economists and psychologists call it time preference. This is where negative interest rates clash with the fundamental realities of human nature. Say an individual is offered the choice between $1 now and the same

$1 a year from now. Everyone will choose to take the money now. To convince someone to accept the money in the future, you have to offer a premium, such as $1.05. In other words, you have to offer a positive rate of interest, in this example five per cent. This is compensation for waiting to receive the money. And the reason why we must be compensated is that human beings prefer enjoying goods in the present to delaying our gratification until the future. Negative interest rates reverse this. By paying more now and less later, they imply that we prefer the future so much to the present that we are willing to suffer a discount to hold off our satisfaction to another day.

We can die at any moment. Any time we put off something to the future, we risk missing out enjoying on the good things in life while we still can. We need to be paid for that risk.

Right now, it is only some bank shareholders and government bondholders who are suffering from negative interest rates. But whenever public officials oppose people’s ingrained tendencies, the inevitable failure of such policies is met with the stubborn implementation of ever more intrusive and draconian measures. That is what happens when you start offending human nature.

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