Good riddance to the worst economic experiment ever

There have been some terrible economic ideas over the past century. Central planning condemned Russia to poverty. Nationalisation created hopelessly inefficient industries. Punitive taxes destroyed incentives, monetary meddling sparked rampant inflation and the EU managed to create a single currency so dysfunctional it has crippled a whole continent. It is hard to match those. Even so, in their own way negative interest rates were up there with the most dangerous – which is why we should all be grateful to Sweden for quietly calling time on them.

Even with negative interest rates, Sweden's economy has been sputtering.
Even with negative interest rates, Sweden’s economy has been sputtering.Credit:AP

At the close of last week, Sweden’s central bank, the Riksbank, which happens to be the world’s oldest, ended its five-year experiment with negative rates. The reason? It wasn’t that the economy was too strong. It was that negative rates were not helping – and may well have been making matters worse. In truth, the Swedes have done the world a huge favour. We may need new ways of stimulating the economy. But interest rates below zero risked doing substantial damage to the economy, and the sooner central banks give up the whole misguided experiment the better.

True, even after the rate rise no one in Stockholm or Malmo is exactly going to be losing sleep over the soaring cost of their mortgage. Borrowing is still remarkably cheap by any historical standards. Interest rates were only raised from minus 0.25 per cent to zero and there are no plans to raise them any further. But it was the thinking behind the move that was significant. “If negative nominal interest rates are perceived as a more permanent state, the behaviour of economic agents may change and negative effects may arise,” the bank said in a statement on the move.

Rewind a couple of years, and negative rates were all the rage. In fairness, there was a certain twisted logic to them. In the wake of the financial crash, and faced with a permanently sluggish economy, central banks had slashed interest rates all the way down to zero or so close to that figure it made no difference. As any mathematician will tell you, once you get to zero the only place you can go next is into the minus numbers. With negative rates, it would actually cost you money to hold money at the bank, and, bizarrely, you would actually get paid to borrow as well. If that didn’t persuade people to get out and spend their cash, and to start racking up as much debt as they could, it is hard to know what would. All that extra spending should stimulate growth, at least in theory. The Swedes took rates into negative territory, and so did the Swiss, the European Central Bank and the Japanese. It might not have been long before the Federal Reserve and the Bank of England followed that lead.


The trouble is, there is little sign it has worked. The Swedish economy is far from a disaster. But with projected growth of just over 1 per cent for this year it is hardly firing on many cylinders. Inflation is below target, industrial output is down this year and business confidence is falling. Switzerland is still battling a massively overvalued currency, Japan is stuck in the same comatose state it has been for a couple of decades, and the eurozone is sliding rapidly into a German-led recession. There is no evidence that negative rates have lifted growth significantly.

That wasn’t the real problem, however. Plenty of policies are a bit of a damp squib. But negative rates risked doing real and lasting damage to the wider economy. Why? There are three reasons. First, if you set out to deliberately destroy the banking system it would be hard to think of a better way of going about it. The difference between what they pay to lenders and what they charge to borrowers is how banks make money, and how a credit system is created that recycles money through an economy. Rates below zero rip that system up, and leave no way of distributing cash between savers and investors. Is that an improvement? Not really.

After five years, the Riksbank ended its negative rates experiment.
After five years, the Riksbank ended its negative rates experiment.Credit:Bloomberg

Next, they create perverse incentives, encouraging people to take their money out of cash and into any kind of alternative asset, and they actively punish anyone who tries to save. Zombie firms are kept alive and there is no longer any incentive to manage investments prudently. Is that healthy? Again not really. Finally, negative rates wildly distort asset prices. They push up the prices of property and any other form of non-monetary asset (at one point the country’s most successful new company Spotify threatened to leave because its staff couldn’t afford the rents). Instead of stimulating demand they end up destroying it.

With the global economy still dangerously weak, central banks may well need other ways to boost demand once interest rates have hit zero. There are other options, however. Quantitative easing has worked reasonably well. Governments have plenty of space for increased spending and cutting taxes; it has worked in the United States, and may well work in this country in the coming year. And there are still other options left to experiment with – taking student debt on to the central bank balance sheet and quietly cancelling it is one obvious option, and so is direct funding of green initiatives such as electric cars.

But negative interest rates were a terrible idea. They made a mockery of money and distorted the market. It remains to be seen how long it is before other central banks follow that lead. In the meantime, however, we should be grateful to the Swedes for calling an end to the whole experiment – and thankful the Bank of England never tried to take our interest rates below zero, and, in the wake of the Swedish decision, almost certainly never will.

Telegraph, London

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