Now, thinking through this lending scenario, is there any way in which negative interest makes sense?  Maybe. It makes sense if liquidity is undesirable. Or it makes sense, at least to some central bankers, if you want to make liquidity undesirable in order to encourage people (and lenders) to take more risk. However, the data is all beginning to show that consumers and even some businesses are actually saving more money in low-interest-rate or negative-interest-rate environments.

Why would liquidity be undesirable? It would be if there was nothing of value to buy with your money. If you’re lost in the desert, having a thousand dollars in your pocket does you no good. You would trade it all for a gallon of water. There isn’t any water, so your money is worthless. So is your credit card.

How can undesirable liquidity pertain in a whole economy? Cash is useful to the extent that you can buy goods and services, but you can only buy so much. Beyond a certain point, liquidity becomes bothersome because you have to store and protect it. This effort consumes time – the one resource we can’t replace.

Is it coincidence that cash is losing value at the very time technology has brought the whole world to our fingertips? What would the knowledge you can now get for free on the internet have cost in the 1970s? Quite a lot, I assure you.

I say all this to make a point: Even if we didn’t have central banks manipulating interest rates, rates might be very low just by virtue of our modern technology and circumstances. I actually think they would, but that is not an experiment we will be able to run. I’m just speculating about what might happen – which, come to think of it, is what central banks now do. They speculate that their radically new actions will have particular results, but they have no empirical evidence to verify that this is true. So when you add central banks to the equation, interest rates get even lower because they manipulate them down. But that’s quite a different scenario than the below-zero yields we see in Europe and Japan right now – and may well see in the US when the next recession strikes.

NIRP Problem #1: Failure To Stimulate

The Federal Reserve’s mission is to maintain a stable inflation rate while spurring employment. Its main tools are control over the money supply and interest rates. Lately exercising that control has meant keeping interest rates extremely low, especially by historical standards.

That’s simple enough, but recognize the grand and unproven assumption here: Lower interest rates will create higher demand for goods and services. If that’s true, the Fed can stimulate economic activity by pushing rates lower and keeping them there.

But is it really true? Certainly not for the last eight years. We’ve had short-term rates near zero the entire time and long-term rates at historical lows. Yet, as measured by GDP or any other standard, economic growth has been mild at best. This dearth of desired results is a real problem for central bankers everywhere

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