- The RBNZ continues to entertain the idea of a negative Official Cash Rate (OCR) to provide additional economic stimulus
- There is global precedent, but the associated lower policy efficacy and financial stability risks cause much debate
- A negative OCR cannot be ruled out and keeping the option open is likely helping to anchor short-term interest rates and the NZD
- The RBNZ’s revealed preference for QE, however, is clear and an expanded Large Scale Asset Purchase (LSAP) programme remains most likely if further stimulus is needed
A negative interest rate is a strange concept. Instead of being paid to deposit money, you are charged. But this is exactly what markets believe New Zealand banks will be faced with, from early next year, on their settlement account balances at the Reserve Bank of New Zealand (RBNZ). Our central bank continues to entertain the idea of a negative OCR as an option to further lower interest rates and provide additional economic stimulus. This was the message in this month's Monetary Policy Statement (MPS), where the RBNZ almost doubled its Quantitative Easing (QE) or Large Scale Asset Purchase Programme (LSAP) to $60bn (20% of GDP) from $33bn. It came in response to an economic outlook where, even in its most optimistic “baseline” scenario, COVID-19 containment measures see GDP growth decline almost 24% this quarter, and the economy not producing at capacity until Q3 2022. In this scenario, the unemployment rate reaches 9% in Q3, house prices fall 9% this year and annual CPI inflation is briefly negative in Q1 2021.
We know from global experience that zero is no longer the floor for interest rates. Prior to the Global Financial Crisis (GFC), most people did not think interest rates could be negative, as depositors would simply withdraw their savings as bank notes. While the post-GFC period has seen a zero lower bound persist for retail deposit rates, countries that have implemented negative central bank policy rates of as much as -0.75%, in the case of Denmark, during this time have shown us two things. Firstly, deposit and lending rates that trade at a spread to official policy rates can decline – providing at least some support to economic activity. Secondly, deposit rates for large businesses can become negative if the interest cost does not exceed that associated with safely storing large amounts of bank notes. Countries that have implemented negative policy rates include Japan, the euro area, Switzerland, Sweden and Denmark. All except Sweden still have them.
The efficacy of negative policy rates, however, is fiercely debated. Recent analysis by the San Francisco Fed found that, once the central bank policy rate is below +0.50%, its efficiency is 60-90% of its efficiency when the policy rate is above +0.50%. Proponents say that, even though rate cuts are less effective, they are not ineffective. There is often room for retail deposit rates to fall while remaining positive. New Zealand 6-month term deposit rates, for example, are still above 2% with an OCR at just 0.25%. Along with lower lending rates and a weaker exchange rate, this provides economic stimulus. Opponents emphasise low efficacy and increased financial stability risks via smaller interest margins (the spread between lending and deposit rates) and a reduction of bank profitability that may also impair the willingness and ability for banks to make loans. Other concerns include a possible reduction in spending from those that rely heavily on income from deposits and that the signal from negative interest rates is a cautious one that may lead to a deterioration in confidence. The arguments of opponents are best characterised by the “reversal interest rate” concept – a policy rate at which accommodative monetary policy reverses its intended effect. The US Federal Reserve (the “Fed”) and Reserve Bank of Australia (RBA) are both strong opponents of negative interest rates, but the severity of the COVID-19 economic shock hasn’t stopped markets pricing some chance of a negative Fed Funds rate in around one-years’ time.
While a negative OCR cannot be ruled out and keeping the option open is likely helping to anchor short-term interest rates and the New Zealand Dollar (NZD), the RBNZ has noted many other stimulus options it still has available. These include an expanded LSAP (possibly including foreign assets and therefore placing downward pressure on the NZD), a new term-lending programme and providing additional forward guidance with support by receiving the fixed leg of interest rate swaps (a position that would lose money should interest rates rise).
The RBNZ’s revealed preference for QE is clear, and an expanded LSAP programme remains most likely if further stimulus is needed. The LSAP programme is limited; currently it is capped at 50% of outstanding government bonds, but the cap is arbitrary and could easily be increased. It has been based on size of global QE programmes, as a proportion of outstanding issuance, and seen as a level beyond which its bond buying may distort markets. But that is one of the goals of QE! To take bond yields to lower levels than they would be otherwise.
 Ulate Campos, Mauricio. “Going Negative at the Zero Lower Bound: The Effects of Negative Nominal Interest Rates,” Federal Reserve Bank of San Francisco Working Paper 2019-21. https://doi.org/10.24148/wp2019-21
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