The European Central Bank (ECB) has announced that it will be lowering interest rates and implementing a negative rate on bank deposits for the very first time in the central bank’s history. According to the statement, the bank slashed its main lending rate to 0.15 percent and reduced its rate on emergency overnight loans by 35 basis points to 0.40 percent.
One reduction that is generating international headlines is the negative interest rate. The ECB reduced the rate on bank deposits parked overnight with the central bank to negative 0.1 percent. This means that it will charge commercial banks for keeping their money at the ECB.
The purpose of such an initiative is to encourage financial institutions to lend to businesses instead of hoarding the reserves. However, critics of the monetary policy move say it will lead to massive price inflation unseen in half a century. Essentially, a tsunami of inflation and euro devaluation is expected to engulf the eurozone in the near future.
“In pursuing our price stability mandate, today we decided on a combination of measures to provide additional monetary policy accommodation and to support lending to the real economy,” said ECB President Mario Draghi in a statement to reporters at a press conference Thursday.
Draghi warned that more tools could be applied to stimulate the economy. “Are we finished? The answer is no. We aren’t finished here. If need be, within our mandate, we aren’t finished here,” added Draghi. “Now we are in a completely different world.”
The unintended consequence is that depositors will refuse to put their money into banks and instead seek out safer assets to park their funds since they’re being charged to have financial institutions hold clients’ funds. The result would be diminished available capital in the banking system to be lent out for productive uses.
Here is what Harvard economist N. Greg Mankiw stated at a 2010 Boston Fed conference (via New York Times):
“What a depositor is going to do is say, ‘Well, if they’re going to charge me money to keep my money at the bank, I’m just going to keep my money at home,’ and the only thing you’ll generate is a demand for safe assets — and by that I mean . . . they’re going to be buying a bunch of safes so people can put their money in their safes rather than in the bank.”
Of course, central banks hope this policy will spur the economy and lead to more consumption but when a currency loses its value then it maintains a severe paucity of purchasing power. In other words, the citizens are hurt the most with these monetary experiments.
What should also be noted is that this isn’t the first time that a central bank has instituted negative interest rates. Denmark and Sweden, for instance, experimented with negative rates in the past several years and it failed because the public policy endeavor devalued the Swedish Krona and the Danish krone. Both countries quickly reversed these measures.