Could a Second Wave of COVID-19 Bring Negative Interest Rates?

By: John Trefethen, Director & Co-Founder

On Wednesday of this week Federal Reserve (“Fed”) Chairman Jerome Powell said that the central bank is not considering negative interest rates. This has been a consistent stance for the Fed since Sweden’s central bank first deployed negative interest rates in July 2009. Chairman Powell’s stance contradicts the White House’s desire for the Fed to consider negative interest rates to help with the current economic crisis resulting from shuttering the economy to combat COVID-19. Negative interest rates are an unconventional monetary policy that has been deployed relatively infrequently. After Sweden’s foray into negative interest rates in 2009, the European Central Bank (ECB) was the next central bank to pursue this policy when it dropped its deposit rate to -0.1% in June 2014. Since then, central banks for several European countries and Japan have also opted to offer negative interest rates. At first glance, negative interest rates seem counterintuitive. Why would a lender be willing to pay someone to borrow money, considering that the lender is assuming the credit risk? However, in times of crisis, negative interest rates are a tool available to central bank to provide needed stimulus for ailing economies. The role of a central bank is to manage the currency, money supply and interest rates of a state or monetary union with an overall objective to manage the economic health of its constituent state / union. Negative interest rates are an example of a central bank using interest rates to manage the health of the economy. With negative interest rates, cash deposited by a financial institution at a central bank yields a storage charge. The storage charge is in lieu of the opportunity to earn interest income. The idea behind negative interest rates is to incentivize banks to lend money to its customers who in turn will spend in the economy, rather than have banks store their cash reserves at a central bank. This is critical being that consumer spending is the single most important driving force of the US economy. For now, the Fed has battled this crisis through fiscal policy that has included massive spending and loan purchases – more than expected, to be sure. However, flooding the economy with too much cash can be an impetus for inflation. A second wave of coronavirus infections could prompt the Fed to consider a range of new policy options, including cutting interest rates below zero. Many analysts have doubted the effectiveness of such a policy, citing the experience of some European countries and Japan that struggled to grow their economies after adopting negative rates for years. But if the US economy struggles for an extended period of time, or if there is a second wave of COVID-19 infections (as many have predicted) that stalls the economy this fall, policymakers are going to be compelled to try new things to jumpstart the economy – and that may bring negative rates forward as the next best option.