1

TheInterestRateunbound?

Jean-PierreDanthine+

May2016-Preliminary

1. IntroductionSince2014fivecentralbanks,includingtheSwissNationalBank(SNB),havesettheirpolicyratesbelowzero.InthisnoteIreviewelementsoftheserecentexperiences,focusinginparticularontheSwisscase.Idothisinsearchofapreliminaryanswertothequestion:dothesedevelopmentsrepresentthepremisseofafullemancipationfromtheZLB?Centralbanks’motivationsforgoingbelowzerohavebeendiverse.TheclearestcasesareprobablythoseofDenmarkandSwitzerland.Inthesetwocountriestheunambiguousgoalwastoprotectanexchangerateparity.ThedaniskkronehasbeenlinkedwiththeEuro(andbeforewiththeMark)fordecades.WhenthecredibilityofthislinkcameintoquestioninJanuary2015,theCentralBankofDenmark(DNB)decidedtoimposeanegativerateoncommercialbanksdepositswiththestatedobjectiveofdiscouragingspeculationbydecreasingtheexpectedreturnoncapitalflowingintoDenmark.Withfoursuccessivecutsovera2.5weekperiodtheinterestonbankdepositsreached-75bpbymid-February2015.Withthepressureonthekronordiminishingtherewasthebeginningofareversal–amoveupto-65bp-inearly2016.TheSwissNationalBank’s(SNB)decisionattheendofDecember2014wasofthesamenature.Anegativeinterestrateonbankdepositsof-25bpwasannouncedonDecember18(butthedecisionwastobeeffectiveonlyonemonthlater)withthegoalofalleviatingthepressurebuildingupontheexchangeratefloorrelativetotheEurothathadbeenineffectsinceSeptember2011.Afurtherdecreaseoftherateonbankreservesto-75bpwasannouncedonJanuary15,2015,togetherwiththeabolitionofthefloor.Heretheobjectivewastoreinstateaninterestratedifferentialwithrespecttotheeurozone,inparticular,tolimittheappreciationoftheCHFthatwasviewedastheinevitableresultofabandoningthefloor.TheconstraintoftheZLBisparticularlyacuteforasmallopeneconomywithasafehavencurrency.PlacedinthisuniquesituationtheabilityoftheSNBtomaintainanegativeinterest

+ParisSchoolofEconomicsandCEPR.PaperpreparedforpresentationattheBrookingsconferenceon“NegativeInterestRates:TheLessonsfromEurope”,June6,2016.ThehospitalityofEIEF,Roma,isgratefullyacknowledged.

2

differential,notablywithrespecttointerestratesoneurodenominatedassets,iscriticaltodeliveranappropriateexchangerate.Historicallythisinterestrate‘bonus’,whichisthecounterparttotheinsuranceagainsttaileventsthatisbundledwithaCHFinvestment,exceeded150bp(forthe3monthLibor)asanorderofmagnitude(Figure1).Bycompressingshortmaturityratestowardszero,theZLBmakesitimpossibletomaintaintheinterestratedifferentialattherequiredlevel,aconditionthatamplifiestheappreciationpressuresaccompanyingtheoccurrenceofcrisis(whichexacerbatesthedemandforthesafehaven).TheZLBthusrepresentsaparticularlysevereconstraintonSwissmonetarypolicyandthestakesofremovingoralleviatingthisconstraintarecorrespondinglyelevated.Asacomplement,letusnotethatthedomesticeconomyatthebeginningof2015washealthywithexpectedgrowthabovepotentialandaboomingresidentialhousingsector.Thatis,thestateoftheSwissdomesticeconomydidnotjustifylowerinterestrates;themotivationforthepushbelowzerowasnottoprovideamonetarystimulustoaggregatedemand.Exchangerateconsiderationswerelessdominant,althoughcertainlypresent,intheotherthreecasesofnegativepolicyrates.IntheEMU,JapanandSwedenthemainintentionwastofightanundershootingoftheinflationtarget(theexchangeratewasoneofthechannelsthroughwhichthepolicymovewasexpectedtodevelopitseffect).TheECBmoveditsdepositrateinnegativeterritoryinmid-2014alreadyto“underpinthefirmanchoringofmediumtolong-terminflationaryexpectations”(Draghi-2014).TheECBfurtherlowereditsdepositrateto-20bpinSeptember2014and-30bpinDecember2015.TheRisksbank(-10bpinFebruary2015followedbyfurthercutsto-25bpinMarch2015,-35bpinJuly2015and-50bpinFebruary2016)andtheBOJ(-10bpinJanuary2016)usedsimilarwording.InthecaseoftheRiksbank,negativerateswereannouncedsimultaneouslywiththeintroductionofQE.Theaimwas“safeguardingtheroleoftheinflationtargetasanominalanchorforpricesettingandwageformation”.AfterseveralyearsofQE,theBOJimposednegativerateswiththegoalofstrengtheningaggregatedemandandpromotinganinflationrateclosertothestatedquantitativetargetof2%.Thegoalofdeliveringa‘traditional’monetarystimuluswiththehopeofrevivingaggregatedemandandreachinganinflationtargetdistinguishesthesethreecasesfromthoseoftheDNBandSNB.Adistinctivecharacteristicoftheexperienceofthefivecountrieswithnegativeratesisthattheyhavehadnoimpactontheinterestrateappliedbybanksonretaildeposits.Thisseemstobetheresultoftheresistanceofcommercialbankstoadverselyaffecttheirretailcustomersforfearofseveringclientrelationships.Itisalsopartlyaresultofthepolicydesign,whichmayhavebeenintended,bythecorrespondingcentralbanks.Theprecisedesignofthenegativeratepolicyiscountryspecific.Itdependsnaturallyonthepeculiaritiesofeachcentralbank’smonetaryoperations.Butitisalsoafunctionoftheimpacttheadoptedmeasureislikelytohaveontheprofitabilityand,potentially,onthefragilityofthebankingsystem.Alleviatingtheburdenimposedbynegativeratesonbanksislikelynecessaryforjurisdictionswheretheimpositionofnegativerateshasbeenprecededbyasignificantinjectionofliquidity(seeCechettiandSchoenholz,2016).Whetheritispossibletoalleviatetheburdenonthebankingsectorwithoutatthesametimeweakeningornegatingthepotentialimpactofnegativeratesontheeconomydependsontheintentionsofthecorrespondingcentralbank.TheSwisscaseisagaintheclearestinthisrespect.TheinjectionofliquidityprecedingtheimpositionofnegativerateshasbeenthelargestasashareofGDP

3

withtheSNBbalancesheetapproaching100%ofGDP.SincethetransmissionofthenegativeratestobankcreditswasnotessentialgiventheexclusiveERmotivation,exemptingbanksfromtheinterestchargewasrelativelyinnocuousprovidedmarginalinterestrateswereguidedtothedesiredlevel.ThisresultedintheSNBimposingalowrateof-75bponbanks’depositsattheSNBwithalargeexemptionthresholdoftwentytimesrequiredreserves1.IteffectivelymeantthatbankscollectivelyweresubjecttonegativeratesfordepositstotallingCHF170bil.whiletheirtotaldepositsamountedtoCHF473bil.asofFebruary2016.ItmaybenotedthatwithoutthisexemptiontheinterestpaymentfromthebankingsectortotheSNBwouldhaveamountedtoasubstantialfractionofnormalprofits.FortheECBandJapanwhohadpreviouslyengagedinsignificantQEoperationsbutwhosegoalforthenegativerateswasbroader,thetrade-offismoredelicateanditisnotclearthattheobjectivesofmaximizingthepolicyimpactiscompatiblewiththeperceivedneedtosparebanks.Itisworthsayingafewwordsonthepublicreactiontothisnovelpolicymeasure.Negativenominalinterestratesarecounter-intuitiveevenwhennegativerealrateshavebeenhistoricallyfrequent.ThedecisionoftheSNBtogonegativehasgeneratedalargeamountofmostlyacrimoniousdiscussion.Thegeneralpublichasdifficultiesunderstandingthelogicofnegativeinterestrates.Theyareviewedas‘unnatural’andameasureoffinancialrepression.Howcanitbethatasaverisnotrewardedforpostponingconsumption?Indeedtheworldmustbeupsidedownwhenthelendermustremuneratetheborrower!Theadventofnegativerateshasexacerbatedthediscussiononthe‘spoliation’ofsaversthathadstartedwiththeeraofultralowrates.Thepensionfundlobbyhasbeenparticularlyvocal.Byimposingnegativerates,itissaid,theNationalBankmakesitimpossibleforpensionfundstoreachtheirreturnobjectives.Thepublicinterestrequiresexemptingpensionfunds,inparticularthepublicsocialsecurityfund,fromtheinterestcharge.Anotherdimensionofthepublicdiscussionrevolvesaroundtheexemptionpolicy.Theprivatebank(wealthmanagers)lobbyhasbeentheloudest.TheincreaseinliquiditysincethecrisishasbeendifferentiallydistributedamongthethreegroupsofbanksrepresentedinFigure2withthe“otherbanks”,dominatedbytheprivatewealthmanagers,outpacingtheothertwobankgroups.Thiscanbeseenastheadventof“cashinCHFattheSNB”asanew‘ultrasafe’assetclassinthecontextofthecrisis,particularlypopularamongthewealthyandconservativeinvestor-clientsofthesebanks.Theresultofthisdevelopmentisthatthedefinitionoftheexemptionthresholdasamultipleofrequiredreservesdidnotrelievethesebanksasmuchastheircompetitors,andtheyarebearingthelargestshareoftheburdenofthepolicy.Giventheirreluctancetotransmittheinterestchargetotheirclientsinacontextofheightenedcompetition,theburdenpotentiallyamountedtoasignificantfractionoftheirnormalprofits.Ofcoursethisisnotincontradictionwiththeintentionsofthepolicywiththesebanksbeingthusledtoproposeinvestmentalternativestotheirclients(notablyinothercurrencies)andtoincentivizethemtochoosethesealternativesbyatleastthreateningtopassonthenegativerates.Butthelatterhasoccasionallybeenexploitedbycompetitorswithfreemarginstoattractnewaccountsleadingtocriesofunfairnessandanintensedebateandlobbyingeffort.Giventhetechnicalnatureoftheissueandthegeneral

1CalculatedwithNovember2014asareferenceperiod.TheexemptionisCHF10miosforbanksnotsubjecttominimumreserverequirements.

4

attitudetowardsnegativeratestheclaimofunfairnesshasattractedacertaindegreeofsympathy.Allthisisrelevantbecause,inadirectdemocracy,evenlegitimateeconomicideashavelittlefuturebeyondacertainlevelofunpopularity.ThequestionIwanttoaddressinthisnoteis:dothesedevelopmentsportendthebeginningoftheendoftheZLB?Therearetworelatedelementsoftheresponsetothisquestion.First,onemustaddresstheissueofhowlowonecango?TheendoftheZLBisinsightonlyifonecangosubstantiallylowerthanthecurrentlyobservedlowerbound.Afterall,ifthelatter,-.75%,turnsouttobethelimit,themarginofmaneuveringforcentralbanksexposedtopermanentlylowratesisunlikelytobesufficient.ThisisnotablythecaseinSwitzerlandwhererestoringthenormalinterestratedifferentialwhenthemajorcentralbankshavetheirpolicyratesatzerowouldrequirealargemovebelowzerobytheSNB.Butthisisalsotruemoregenerallygiventhatthemoreimportantimpactonlongratesisboundtobeonlyafractionofthecutinthepolicyrate.Thesecondissuetobeaddressediswhetherthetransmissionmechanismremainsintactunderzero.Again,thedemiseoftheZLBwouldappeartobenearonlyifthetransmissionmechanismworkssymmetricallyaboveandbelowzero,oratleastifitisnotsignificantlyweakenedwhengoingnegative.Ilookatthesetwoquestionsinturn.

2. Howlowcanwego?Therehasbeenamodestbutneverthelesssignificantevolutionofthoughtonthisquestion.Afewyearsback,theZLBwastakenliterallyandleftunquestioned.SincethentheZLBhasgivenwaytotheeffectivelowerbound(ELB)!Theissueiswellknown.Incurrent,universal,circumstances,therateofreturnonholdingpapercurrencyisneitherpositivenornegative.Hoardingsignificantamountofpapercurrency,however,hasacostintermsoftransportation,safestoragecapacity,insuranceanditmayfurtherhavesomeinconveniencefeatures.Byaffectingthepossibilityofavoidingnegativeinterestratesonbankdepositsthroughpapercurrencyhoarding,thesecostsdefinethelowerlimittonegativeinterestrates.Todaytheyappeartobe“oneinch”lowerthanwhatonewouldhavethought.AccordingtoBernanke(2016)theFedstaffconcludedin2010thattheinterestratepaidonbankreservesintheU.S.couldnotpracticallybebroughtlowerthanabout-0.35%.Otherestimateshadplacedthecostofcashhoardingatcloserto.50%.SincethenbothDenmarkandSwitzerlandhavereachedthelevelof-.75%.withoutunleashingarushforcash.Itisnotclearthatonecangomuchlowerformuchlonger,however.Switzerlandisanexpensivecountry.ThevariouscostsmentionedabovemaywellbealittlehigherthanthecorrespondingestimatesfortheUnitedStates.Switzerlandisalsoasmallcountrywheremoralsuasionbythecentralbankcanbeeffective,atthemargin,inpreventingbanksfromtakingactionsthatcouldbeviewedasunderminingamonetarypolicydecisionofimportanceforthecountry.Fromapurecostperspective,itislikelythatcashhoardingstartsjustifyingitselfinthevicinityofthecurrentrates.Togosignificantlylower,thecontextmustbealteredquitefundamentally.Inordertothinkaboutthisissueletmestartwithanassumption.ItisthatCentralBankswouldwanttoavoidpapercurrencyhoardingbythegeneralpublic(ashasbeenthecasesofar).Centralbanks

5

havealegalobligationstoprovidethenationalmeansofpaymentandtheyholdstocksofpapercurrencytomeetsuddenincreasesinthedemandforcashbuttheytypicallydonotstoreenoughbillstomeetdemandifpapercurrencyhoardingweretobecomepervasive.Rationingpapercurrencytopermitarbitrarylowinterestratesisnotpartofasustainablemonetarypolicy.Yetifratesweretofallmuchlowerandwereexpectedtoremainlowforalongenoughperiod,andifretaildepositorsweresubjecttothesenegativerates,thenpapercurrencyhoardingbythepublicwouldlikelybecomeprevalentandthefirstindicationsthatacentralbankmayhaveaproblemmeetingthedemandforcashwouldonlyacceleratethemove.IpostulatethatthepreferenceofCentralbanksistoavoidriskingsuchanoutcome.Twodirectionstoavoidpapercurrencyhoardingbythepublicwhilepermittingarbitrarilylowinterestrateshavebeensuggested.Thefirstconsistsinabolishingpapercurrencyaltogether(e.g.,Buiter,2009,Rogoff,2014),theotherconsistsinsubjectingpapercurrencyitselftonegativeratesbyintroducinganexplicitexchangeratebetweenpapercurrencyandelectronicmoney.Withpapercurrencysteadilydepreciatingagainstbankordigitalmoneyoneeffectivelygeneratesanegativeinterestrateoncurrency(AgarwalandKimball,2015).Thefirstisclearlymoreradicalthanthesecondandindeedthelatterwasguidedbytheobjectiveofproposing“apolicyataminimumdistancefromthecurrentmonetarysystem”.Nevertheless,directlyexposingthegeneralpublictothenegativeinterestratepolicywouldbeasignificantdeparturefromthecurrentsituation.Forreasonstobediscussed,noneofthesealternativesappeartobeimmediatelyavailable,certainlynotintheSwisscontext,asbothwouldrequiresignificantlegalchanges.Iwillpresentamoremodest,lessradicaloptionthatmightbewithinreach.Theideaistopermitimposingsignificantlylowerrateswhilesimultaneouslymakingsurethenegativeratesarenottransmittedtothegeneralpublic.Theimpactofthiscompromiseonthetransmissionmechanismisnotnegligible,however.Abolishingpapercurrency?TheSwisslovepapercurrency.ContrarytowhatisobservedinSweden,theuseofcashinSwitzerlandisstillverycommonincluding,incertaindomainsatleast,forlargepayments.AsFigure3shows,thedemandforpapercurrencystoppeddecreasingasaproportionofGDParound1990andithasincreasedagainasaconsequenceofthecrisissince2008.IncidentallytheincreaseoflatehasbeenconcentratedonCHF1000billbutitdoesnotcorrelatewithanincreaseincriminalactivities.Itisperfectlytimedwiththeadventofthefinancialcrisisthatcausedanincreasedmistrustofthebankingsystem.Aproposaltoabolishpapercurrencypaymentswouldforsureprovokeaverylivelydebatewithargumentsbearingonsafety(theftvs.cybertheft),cost(theuseofpapercurrencyisviewedasfree,creditcardchargesarehigh)andtheprotectionoftheprivatesphere.Itwouldbecertaintoendwithapublicvotewhoseoutcome,asoftoday,couldsafelybepredictedtobearesoundingNO.Allinall,my(Swiss)takeisthatpapercurrencywillcirculateforawhilelonger,maybeuntilthecentralbankisreadytoissuecrypto-currencyratherthaninpaperform.Anewpapermoneyserieswasjustputintocirculationafewdaysago(April2016)replacingaseriesthatwasintroducedbetween1995and1997.Itcanbeexpectedthatthenewserieswillcirculateatleastuntil2030.Thesecondapproach,forcingnegativeratesonpapercurrencybyintroducinganexplicitexchangeratebetweenpapercurrencyandelectronicmoney,isattractivebut,inSwitzerlandatleast,itwouldequallyrequiresignificantlegalchanges;notablybutnot

6

exclusivelybecausepapercurrencyisthelegaltenderwhichwouldhavetobereplacedwithelectronicmoney.Inandofitself,suchalegalalterationwouldprobablybewithinreachbutviewedasameanstoreachingthegoalofpermittingtheextensionofnegativeinterestratestoretaildepositors,theoutcomewouldbemuchlessclear.Thepublicdiscussionwouldsurelyfocuslessonthemeansthanonthegoal.Asarguedabovetherecentexperience–admittedlyveryshort–withnegativeratesshowsthatthegeneralpublicseesthemascounter-intuitiveandunnatural.Thenegativereactionshavebeencontainedbecausethemaninthestreetwasnotaffectedexceptindirectlyviahispensioninvestments.Criesagainstsuchapolicyaresuretobeevenlouderwiththeprospectofeveryonebeingexposedtoanegativeinterestbothonhisbankdepositandonhispapercurrencyholding.Hereaswelladifficultdemocraticdebateissuretotakeplace,theoutcomeofwhichwouldbehighlyuncertain.ForthereasonsjustdescribedIbelievenoneofthesechangesisreadilyavailableatleastforthecentralbankofaconservativecountrywithdirectdemocracy.ThereexistshoweveranintermediateoptionforwhichtheSwissexperiencemaybeseenasaprelude.Itwouldprovideapractical,almostready-to-adoptalternativetoenforcingasignificantlymorenegativeinterestratepolicy.Theideaistoimposeafeeonwholesalecashtransactionsbetweenthecentralbankandcashhandlerswhilesimultaneouslyensuringthatthecostisnotpassedontoretaildepositors.Tomakethissustainableanecessarybutpossiblyalsosufficientconditionistodesignatieredsystem.Withoutexemptingmostofbankreserveseithertheburdenonthebankingsystemwillbesuchthatbankswillbeforcedtotransmitnegativeratestoretaildepositorsor,iftheyarepreventedfromdoingso,theinterestchargecouldbecomeexcessive,possiblyleadingtobankfailuresandacreditcrunch,i.e.,theoppositeofthesituationonepresumablywantstopromote.AlleviatingsignificantlythefinancialburdennegativeratesplaceonbanksmakesitpossibleandlikelythatbankswillnotchargenegativeratesonthedepositsheldbyretailclientsasiscurrentlythecaseinSwitzerlandandallothereconomicareaswithnegativerates.Thisstatementaccordswithbanks’observedreluctancetopassonnegativeratestotheirretaildepositors.Ifneedbe,thisstateofaffairsmaybeconsolidatedwithalegalobligation(suretobepopular)ofanon-negativeinterestrateondepositbalancesinferiortoacertainlimit(saythe100klimittypicallyusedfordepositinsurance).SuchalegalobligationisineffectinBelgiumforinstance.Oncethisisassured,asystemmustbedesignedtoavoidwholesalecashhoardingbybanksandinstitutionalinvestors.Thiscanbeachievedinvariouswaysdependingontheparticularinstitutionalset-up.InSwitzerland,forexample,asmallnumberofintermediariesareresponsibleforthetransportofcashtoandfromthecentralbankmeaningtrackingdownindividualwithdrawalsanddepositsisasimpleaffair.ThesimplestsystemwouldinvolveimposingafixedfeeonallcashwithdrawalsfromtheCentralBankwithanexemptionthresholdcorrespondingsaytotheaverageyearlywithdrawalofthelast5years.Thatis,withdrawalsinexcessofthenormalusagedeterminedbytheneedsofthepaymentsystem(correctedbyatrendifneedbe)wouldbetargeted.Alternatively,thefeecouldbeleviedoncashdepositstotheCentralBankanditcouldbemodulatedasafunctionofthelengthoftimesincethecorrespondingwithdrawalthusneutralizingtheroleoftime(asareasonablefixedfeewouldbetoosmallifthezerointerestpolicyisexpectedtolastlongenough).Onecouldaswellusethemoresophisticatedproposaltoimplementanexchangeratebetweenpaperandelectronicmoneyatthewholesalelevelbutthisis

7

probablyneedlesslycomplicatedgiventheintention.Herethegoalistopreventbypassingthenegativerateonelectroniccashviawholesalepapercurrencyhoarding:aroughmechanismdesignsufficestoensure‘inmass’hoardingdoesnotpaywiththeresultthatnofeewilleverbelevied.Iamconvincedthatwithsuchasystemsignificantlymorenegativeinterestratesthanobservedtodaycouldbeattained,sufficientlylowtorestorethenecessarymonetarypolicymargininaworldofpermanentlylowerrates.Obviouslythemodestyofthereformneededisnotwithoutanimpactonthecharacteristicsofthemonetarytransmissionmechanism.

3. Isthetransmissionmechanismunaffectedbelowzero?Whatcanwesayaboutthemechanismofmonetarytransmissiononcepolicyratesarenegative.Lessonshereareclearlypreliminary.Thisisthecasefirstbecausetheexperiencewithnegativeratesisshortandadjustmenttimeisanimportantfactor.Theanticipateddurationofthepolicymattersgiventhatbehavioraladaptationshavefixedcosts.Second,themodestyofthemoveonthenegativesideisalsorelevantforwhatwecanhopetolearnfromthecurrentexperience.Mostratesarenotexpectedtogonegativeatapolicyrateoflessthan-1%.Thethirdlimitationofthecurrentexperienceisthat,partlyforthereasonsjustmentionedplustheprevalenttieringsystem,negativerateshavenotbeentransmittedtoretailsightdepositsinanyofthefivejurisdictionswithnegativepolicyrates.Thecounterpartofthisfactisthatbankshavealsolimitedthetransmissionofnegativeratestotheassetsideoftheirbalancesheet,i.e.,bankcreditshavenotadjustedoronlytoalimitedextent.Marketrates.Inalljurisdictionswithnegativepolicyratesitappearsthatthetransmissiontomarketrates,shortandlong,onpublicandprivatedebts,hasoperatedinnormalfashion.Thisisclearlythecaseformoneymarketrates(seeFigure4).Thisconformstowhatcouldhavebeenexpected.Thearbitragingpossibilitiesbetweenlendingtothecentralbankandlendingtotheinterbankmarketensurethatthemarketratecannotdeviatemuchfromtheofficialrate.Thedifferentialelementisprovidedbyexpectationsonceonemovesbeyondovernightdeposits.Suchexpectationshavepushedthe3-monthLiborontheCHFsometimessignificantlybelowtheratesetfordepositsattheSNB.Everywheretradevolumesareverylowbecauseofsuper-abundantliquidity.Wheretheintroductionofnegativerateshasbeenaccompaniedwithafurtherincreaseinliquidity(Euroarea)tradevolumeshavebeenfurthernegativelyaffected.ThesituationistheoppositeinSwitzerlandwherethedesignoftheexemptionthresholdshasstimulatedovernighttradingbetweenbanksbelowthethresholdwillingtoabsorbliquidity(ataprice!)andthoseabovethethreshold.SeeFigure5.Thetransmissionappearstohavebeensymmetricaswellforinstrumentsoflongermaturity.Figure6showsthatthereactionofinterestratesonSwissgovernmentbondstotheintroductionofnegativerateshasbeensignificant.Inacontextofdecreasingrates,inparticularatlongermaturities,onecannoteasilyisolatethepureeffectofthepolicymove.Nevertheless,takingintoaccountthefactthattheSNBfirstannouncedtheintroductionofnegativeratesonDecember18,2014atalevelof-20bp,effectiveonemonthlaterandthenafurtherdecreaseto-75bponJanuary15,2015,effectiveonJanuary20,thefallinrates

8

overthetwomonthperiod–endofNovembertoendofJanuary–isthemorerelevant.Theone-yearbondratefellby72bpoverthisperiod,the5-yearfellby76bp,the10yearby38bpandthe30yearby21bp.Inamoresystematicbutstillpreliminarystudy,Grisseetal.(2016)reportnoevidenceofadeclineintheaverageeffectofshortratechangesonlongyieldswhenshortratesmovetonegativeterritory.Figure7reportsobservationsonborrowingratesinCHFfromnon-governmentborrowersaroundtheJanuary15decision.ThesearedailydatacompiledbytheSNB.Theimpactofthedecisiontoimposenegativeratesisclearlyvisibleincludingtheoverreactionregisteredinallmarketsonthedayofthedecisionandthecorrectionobservedinthedaysfollowing.Themoresolidborrowers,includingforeignissuersratedAAAandAA,couldborrowatnegativeratesoverafewdaysinJanuary2015andagaininDecember.Therearenoindicationsthatvolumesofissuanceweremateriallyaffectedbythepassagetonegativerates.Buttheevidencecannotbeviewedasfullyconclusiveheresinceonlyquarterlydataareavailableandborrowingratesfortheseissuershavenotbeenactuallynegativemorethanafewdays.Quantitativelytheimpactoncorporateborrowingratesaresmallerthanthoseobservedforgovernmentbonds.Bankcredits.Incontrasttotheaboveobservations,theevidencesuggeststhepresenceofaclearasymmetrywhenwelookatratesapplyingtobankcredit.Figure8suggeststhatJanuary15wasclosetoanon-eventforbankcredittocorporatecustomers.Althoughthefirstmovetonegativeratesmayhaveinitiatedasmallreactionforlongermaturitycontractsthemovewasfullycompensatedwithinaperiodoftwomonths.Shorttermcontractsdidnotreactatallinthepredicteddirection.Figure9reportstheevolutionofmortgageratesofvariousmaturities.Thesearehighlyrelevantforthemonetarytransmissionmechanismsincemortgagesformthebulkofcreditvolumesinmostadvancedcountries.ThisisparticularlythecaseinSwitzerland.Itappearsthatmarketmortgagerateshavenotfollowedinnegativeterritoryand,evenmoreremarkably,theyhavenotevendecreasedaftertheintroductionofnegativeinterestrates.Ontheonehand,itisreportedthat,withasomewhatsurprisingdegreeofforesight,bankshadpreemptivelyadaptedthecontractsonvariablerate(Liborplus)mortgagesandplacedazeroratelowerboundincaseofthereferenceLibormovingintonegativeterritory.Thatis,therevisedcontractindicatedthatthevariablerateconsistedofthemax(Libor,0)plusamargin.MovingfromazeroLibortoanegativeLiborwasfromthisperspectiveanon-eventandaccordinglyelicitednoresponsefromvariableratemortgages.Ontheotherhand,longfixedmortgageratesafteraslightdecreasefollowingtheSNB’sdecisiontogonegativereversedthenegativetrendthathadbeenobservedsinceearly2014andfoundthemselvesatapproximatelythesamelevelinmid-March2015astheywereinmid-december2014,i.e.,beforethefirstannouncementofnegativeratesbytheSNB.Notethat,fromtheSNB’sperspective,thishastobeviewedasapieceofgoodnewssinceafurtherdropinmortgagerateswouldnothavebeenwarrantedgiventhebooming(bubbly?)Swissrealestatemarket.Howcanwemakesenseoftheseobservations?Thecriticalelementiscertainlythereluctanceofbankstopassonthenegativeratestotheirretaildepositors.WithSwissbanksbeinglargelyfinancedwithdemanddeposits(upto55%oftheirbalancesheetonaverage),thismeansthatthebulkoftheirfundingisnotaffectedbythemovetonegativemarketrates.Bankshavelogicallyattemptedtoprotecttheirprofitabilityandattheminimumthey

9

havestrivedtoavoidlosingontheassetsidewhattheyhavenotbeenabletogainontheliabilityside.Anedoctalevidenceindeedconfirmsthatthedriverofbanks’reactionshasbeentheirfearoflosingprofitablelongrunclientrelationshipsgiventheperceivedresistancetothepolicymeasurebythegeneralpublic.Thefearextendstotheircorporateclientswhoalsohavebeensparednegativeratesevensometimesonlargecashdepositsbutwhosecreditlineshave,forthemostpart,notbenefittedeitherfromthefall,allthistakingtheformofadelicateday-to-dayprocessofclientrelationshipmanagement.Bycontrastthelargeinternationalbankshaveostensiblyimposedverynegativedepositratesonprospectivelargecashdepositsbynewclients.Onthemortgagefront,Brupbacher(2016)indeedcreditssome“heavyrepricing”,withmortgagemarginshavingmorethandoubled(fromaround60bpaboveswapratestoaround150bp),forthereportedriseinnetinterestincomebySwissbanks.Suchanapparentlyfragile(tocompetitiveforces)policymovemayhavebeenhelpedbytheconstantwarningoftheSNBthattherisksintherealestatemarketwereataveryhighlevelandthatcautionwasinorder.Thismayhaveweakenedtheresolveofbankstocompeteonmortgagecreditvolumesandinducedthemto‘coordinate’onmorerestrictivemortgageapprovalpolicies.ThecomparisonbetweenSwitzerlandandDenmarkishighlyinformative(seeFigure10).InSwitzerlandtraditionaldeposittakingbanksdominatemortgagecredit.BycontrastmortgagesinDenmarkareforthelargestpartofferedbyspecificinstitutionsthatfundthemselvesinthemarket.Theretailmortgagerateisthemarketrateaugmentedbythemarginoftheintermediary.Whenmarketratesfellbelowzerotheseinstitutionsnaturallypassedonthefalltotheirclientsandindeedmortgagerateshaveadjustedandhavesometimesfallenintonegativeterritory.Ontheotherhand,banksfinancingthemselvesthroughclientdepositshavenottransmittedthenegativeratestotheirretailclientsbuthaverathertriedtocompensatetheeffectivelyflattenedyieldcurvebyincreasingfeesandcommissions2.Andbanklendingratesfornewloanstonon-financialcorporationshavebeenreportedtohaveincreasedin2015.TheDanishexperienceofcourseshowsthelimitsofthecurrentSwiss‘equilibrium’.Withtimeotherintermediariescouldenterthemarketandoffernegativeratemortgagesthusforcingbankstoreact.ThetwoexistingPfanbriefbanksareprimecandidatesforsuchamovealthoughtheymayhesitate(orbeprevented)tocompetewithbankswhicharetheirmainbusinesspartners(andshareholders?).Thedurationandtheextentofthenegativeratesareoftheessencehere.DomesticSwissbankscanillaffordtolosethemortgagelendingbusiness.Werecompetitionfromnon-banksfundingthemselvesinmoneyandbondmarketsbecomehardtobearbankswouldhavetorespond.Thetemptationtotransmitnegativeratestoretaildepositorscouldthenbecomedifficulttoresist.Exchangerates.ThemostoftenheardquestionaboutnegativeratesinSwitzerlandis:“canyoudemonstratethattheywork?”meaningthattheyindeedhelpalleviatethepressureonthestrongfranc.Obviouslytheanswercannotbecategorical.Interestratedifferentialsaretypicallythedominantvariableinexchangerateequationsandthereisnoevidencethatthepassageunderzerowouldlimittheirinfluence.IndeedonehasobservedsignificanteffectoncapitalflowsinDenmarkandonexchangeratesinSwedenandJapanaftertheirmoveto

2AnincreaseinbankfeeshasalsobeenreportedinSwitzerland.

10

negativeratesbutasistypicalthesemoveswerenotisolatedeventsandotherthingsweregoingon.TheexchangerateimpactappearstohavebeenmorepersistentinSwedenthaninJapanwhileinDenmarkthemovetonegativeratecanbeinterpretedashavingbeensuccessfulineliminatingERpressures.IntheSwisscasethesimultaneouspolicymove(theabolitionoftheERfloor)practicallyguaranteedastrongerfrancandthequestioniswhetherthenegativeratesmoderatedtheappreciation.Welackthecounterfactualbutallevidencesuggestthatthetypicaleffectoccurred.Thedropof75bpinthepolicyratecouldnotmakeupforthespeculativeexchangerategainsexpectedinvolatiletimesandwasasmallpricetopayforaninsuranceagainsttherisksofaGrexitinthefirstpartof2015,butinmorenormaltimesoneexpectstheratedifferencetohelpthecurrencysettletoamorenormallevel.Thisappearstohavebeenthecase(asofMay2016theCHFwasquotedabove1.10totheEuro,alevelthatmanywouldhaveconsideredasuccessfortheSNBthedayaftertheabolitionofthefloor)3.Anecdotalevidencewouldrathersuggestthatsomecategoriesofinvestors,atleast,dohatenegativeratesandmayreactmoreforcefullytoamovefrom0to-75bpthanfrom+.75bptozero.Onthatscoreifthereisanasymmetry,behavioralbiasesmaycausetheaysmmetrytobeinfavorofamoveinnegativeterritory.Impactonbankprofitability.2015appearstohavebeenamoderatelygoodyearsforSwissbanks.Theintroductionofnegativerateshasnotleftaidentiablemarkontheprofitsofthebanks.Ineffecttheinterestchargehasmostlybeenpaidbyindividualorinstitutionalinvestorswhohavebeensubjecttoanegativeinterestbytheirbanks(notablyinternationalbanks)andbyafewwealthmanagerswhohavechosentopreserverelationshipsratherthanpassonthenegativeratetotheirclients.Forbanks,lowandlowerratesareexpectedtohurtincreasinglyastimepassesandoldercontractsarerenegotiated.Innormalcircumstancestheslopeoftheyieldcurveisthedeterminingfactorandtheyieldcurvehasbecomerathersteeper(Figure11).Therelevantyieldcurvemusthowevertakeaccountofthefactthatratesondepositshavenotfallenbelowzero.Asindicated,sofarbankshavebeenabletocompensateontheassetsideoftheirbalancesheetbutitcannotbeguaranteedthatthissituationcanpersistifnegativeratesweretopersistorfurtherdecrease.Itisalsolikelythatsomebankshaveeconomizedoninterestriskhedginggiventhatthepolicymeasurecanbeinterpretedasasignalthatrateswillstaylowforevenlongerthanpreviouslyanticipated.ThisisallthemoresignificantbecauseSwissclientsareincreasinglylenghteningthematurityoftheirfixed-ratemortgages.Inothernegativeratecountriesitisalsoreportedthatbankprofitabilityhasnotvisiblysufferedbutcautionininterpretingtheimpactoversuchashortperiodisequallywarranted.

4. ConclusionsDespitehavingsparedthegeneralpublicwhosesightdepositshavenotbeenaffected,negativeratesarenotpopular.Thecurrentexperimentshavebroughtusclosetothelimitofnegativeratesshortoftakingradicalmeasuressuchaseradicatingpapercurrency.Mytakeisthatthegeneralpublicisnotpreparedtovoteforsuchameasure.Inadirectdemocracythismeansthattheroadisblockeduntilmindschange,whichmayhappenbutonlyveryslowly.Elsewhereoneshouldbeveryreluctanttomaketechnocraticchoicesthatlack

3Inits2015AnnualReporttheSNBreportspurchasesof86.1bill.eurosin2015.

11

minimaldemocraticsupport.Welivedangerouslyenoughinaworldofimportantdemocraticdeficits.InSOEswheretheinterestrateisasimportantforitsimpactontheERasitisforitsroleindeterminingdomesticmonetaryconditions,apragmaticapproachtomoredeeplynegativeratesisconceivable.Itconsistsinimposingfeesonwholesalecashwithdrawals(ordeposits)topreventwholesalecashhoardingwhilekeepingretaildepositorsoutofitbyexemptingthelargestpartofcommercialbankreserves.ThispossibilitycouldbeattractiveforacountrysuchasSwitzerlandenablingtheSNBtorestoreahistoricallynormalinterestratedifferential(notablywithrespecttotheeuro)andthustorecoverawidermarginofmaneuvereveninaworldoflowglobalrates.ThisapproachtobypassingtheZLB,however,isnotwithoutitslimits.First,thecurrentSwissregimeofmortgagecreditbeingintermediatedbybanks,themselveslargelyfinancedthroughsightdeposits,isvulnerabletocompetitiveforces,inparticulartothearrivalofnewentrantsofferingmortgageswithdirectmarketfunding.Second,totheextentthatnegativeratesarenotpassedontoretaildeposits,theapproachoutlinedimpliesanasymmetricaltransmissionmechanism:bankslimitasmuchastheycanthetransmissionofnegativeratesontheassetsideoftheirbalancesheet,thusprecludingafulltransmissionofthenegativeratepolicytotherealeconomy.ThisrendersthispragmaticapproachtonegativeratesunattractivetolargeeconomicareasinneedofamonetarystimulusattheZLB.ForthelattermoreradicalstepsareneedediftheELBistobepushedmuchlowerthancurrentlevels.ReferencesAgarwalR.andM.Kimball,BreakingthroughtheZeroLowerBound,IMFWorkingPaper15/224,2015BallL.,J.Gagnon,P.Honohan,S.Krogstrup,T.Slok,TheLiquidityTrap:WhattoDoaboutIt?ICMB18thGenevaReport(preliminarydraft-May2016)B.Bernanke’sBlog-March182016BechM.andAytekMalkhozov,Howhavecentralbanksimplementednegativepolicyrates?BISQuarterlyReview,March2016BergJ.,DanishsupervisoryauthorityinterviewinInstitutMessine,Tauxd’intérêtnégatifs–DouzeRegards,janvier2016D.Brupbacher,Negativeinterestrates:theSwissexperience,UBSGlobalResearch,March2016BuiterW.H.,Negativenominalrates:threewaystoovercometheZero-Lower-Bound,NBERWorkingPaper15118,2009

12

CecchettiS.andK.Schoenholtz,Howlowcantheygo?e-axes,March09,2016GrisseC.,S.KrogstrupandS.Schumacher,Theresponseoflong-termyieldstonegativeinterestrates,Incompletedraft,April2016RogoffK.,Costsandbenefitstophasingoutpapercurrency,NBERMacroeconomicsAnnualConference,mimeo2014

13

Figure1–TheSwissinterestrate‘bonus’

Figure2–Commercialbanksdifferentiallyimpacted

0

1

2

3

4

5

6

7

8

2000

2001

2002

2003

2004

2005

2006

2007

2008

Libor- CHF- 3m Libor- USD- 3m Libor- EUR- 3m

14

Figure3–Switzerland:RatioofpapercurrencyincirculationtonominalGDP

Source:SNB

Figure4-KeypolicyratesandmoneymarketratesInpercent

1TheovernightSwissaveragerate(SARON)replacedtherepoovernightindex(SNB)inAugust2009.2Chargedontheportionofsightdeposits

exceedingtheexemptionthreshold.3ShadedcorridorrepresentstheSNBtargetrangeforthethree-monthLiborrate.

Sources:BechandMalkhozov(2016)/Bloomberg;nationaldata.

15

Figure5–Repovolumessincetheintroductionofnegativerates

Source:SNB

Figure6–Swissbondyields

Source:SNB

-1.5

-1

-0.5

0

0.5

1

1.5

2014-01

2014-02

2014-03

2014-04

2014-05

2014-06

2014-07

2014-08

2014-09

2014-10

2014-11

2014-12

2015-01

2015-02

2015-03

2015-04

2015-05

2015-06

2015-07

2015-08

2015-09

2015-10

2015-11

2015-12

2016-01

2016-02

2016-03

2016-04

CHFSwissConfederationbondissues- 1year

CHFSwissConfederationbondissues- 5years

CHFSwissConfederationbondissues- 10years

16

Figure7-Yieldsonbondissues(8yearsmaturity)-Variousprivateborrowers

Source:SNB

Figure8–Banklendingrates–Newloanagreements

Source:SNB

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

2014-11

2014-12

2015-01

2015-02

2015-03

2015-04

2015-05

2015-06

2015-07

2015-08

2015-09

2015-10

2015-12

Mortgagebondinstitutions Commercialbanks(incl.cantonalbanks)

Manufacturing(incl.powerplants)andtrade CHFbondissuesofforeignborrowers- AAA

11.21.41.61.82

2.22.4

2014-01

2014-02

2014-03

2014-04

2014-05

2014-06

2014-07

2014-08

2014-09

2014-10

2014-11

2014-12

2015-01

2015-02

2015-03

2015-04

2015-05

2015-06

2015-07

2015-08

2015-09

2015-10

2015-11

2015-12

Maturityofover1monthupto6months

Maturityofover6monthsupto1year

Maturityofover5yearsupto7years

17

Figure9–Ratesoncommercialmortgagesandinvestmentloans

Source:SNB

Figure10:Differentialpass-troughinSwitzerlandandDenmarkSwitzerland Denmark

1Ratesonnewloans.2Ten-yearfixedmortgagerateminus10-yearinterestrateswap.3CopenhageninterestT/Naverage(CITA)swaprates

replacedCiborinDecember2012.

Sources:BechandMalkhozov(2016)/Bloomberg;nationaldata.

0

0.5

1

1.5

2

2.5

3 MortgagesandInvestmentloansrates

Fixedratemortgages>1to6mth Fixedratemortgages>5to7yrs

Fixedratemortgages>10to15yrs Variable ratemortgages (linkedtobasepoint)>5to7yrs

Fixedrate investment loans>1to6mth Fixedrate investment loans>5to7yrs

18

Figure11:SwissYieldCurve