The Phaserl


Negative Interest Rates, NEGATIVE Reactions

by Mark Cliffe, VOX:

As doubts grow about the effectiveness of quantitative easing, monetary policymakers are leaning towards cutting interest rates further into negative territory as their preferred mode of easing. But this begs crucial and untested questions of whether banks will be willing to pass on the cost to their retail depositors, and of how depositors might react if they did so. This column notes a recently published survey in which a large majority of respondents said that they would withdraw their savings, and yet few would spend more. Although it could be argued that savers might react less negatively when confronted with the reality of negative rates, their powerful aversion to the prospect raises troubling questions about the potential effectiveness of this policy tool.

In their struggle to keep up the momentum of economic growth, central banks are turning to negative interest rate policy (NIRP) as their weapon of choice. Amid doubts about the impact of further large-scale asset purchases, the Bank of Japan (BOJ) has recently followed the ECB and other European counterparts in imposing negative rates on the reserves that banks hold with them. Meanwhile, weak economic data has even prompted talk of the Federal Reserve potentially having to reverse course and join the NIRP club.

But there are doubts about NIRP too. In particular, if banks resist passing on negative rates for fear of triggering a deposit flight, they will fail to incentivise savers to spend. NIRP could still work via boosting asset prices or driving down the exchange rate, but, as the BOJ has discovered, this is a confidence trick that is liable to succumb to the vagaries of financial market sentiment.

So are the banks right to fear the zero lower bound (ZLB)? The obvious problem is that we have no experience to go on, since no bank has been brave enough to breach it in a significant way. The banks are clearly concerned that cutting savings rates below zero would lead to a customer backlash and significant withdrawals of deposits. But with loan rates often contractually linked to money market rates, shielding savers from lower rates comes at the cost of bank profitability, capital generation, and willingness to lend. This, in turn, blunts the intended stimulus that the central banks are trying to deliver by lowering rates.

So the response of retail customers to negative interest rates remains largely untested. In an attempt to fill this gap, ING commissioned IPSOS to survey around 13,000 consumers across Europe and – for comparison purposes – in the US and Australia to ask them how they have responded to low interest rates and how they might react to negative interest rates (ING 2016).

Such surveys have an obvious drawback: there is inevitably a gap between what people say and what they do – inertia often kicks in. Nevertheless, the results are remarkable. They indicate that zero is a major psychological barrier for savers. No less than 77% said that they would take their money out of their savings accounts if rates went negative. But only 12% would spend more, with most suggesting that they would either switch into riskier investments or hoard cash ‘in a safe place’.

Survey highlights

1) Response so far to low savings rates

In order to provide a context for the consumer reaction to the possibility that savings deposit rates might go negative, the survey began by asking respondents about how they have responded so far to low interest rates.

Figure 1. Nearly a third of savers have changed their behaviour due to low rates

Source: ING International Survey (IIS)

It asked whether the low rates had prompted a change in their behaviour and, if so, how. Across the 15 countries surveyed, 31% of respondents said that they had changed their savings behaviour (see Figure 1). The figures were higher in Eastern Europe, the UK (37%) and Turkey (47%), where rates have traditionally been higher or more volatile.

As to how savers had changed their behaviour in the light of low interest rates, the most popular answer, accounting for 40%, was that they were saving the same amount, but had switched to longer-term forms of saving (see Figure 2). Across countries, the highest proportion of respondents to have made this switch was in the UK, with 49%, and the lowest was in Austria, with 28%.

Figure 2. How have you changed the way you save?

Source: ING International Survey

The next most popular response, at 38%, was from those who have been saving less – the response most desired by the central banks. That said, ‘saving less’ does not necessarily translate fully into ‘spending more’, particularly for those households relying on interest income.

Meanwhile, the survey showed that a significant minority – namely 17% – of those who have changed their behaviour have actually increased their saving in response to lower rates. This may reflect the fact that the lower income resulting from lower rates may be making life harder for those who have target income or long-term savings goals, forcing them to save more to compensate.

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