Is a Negative Bank Rate the Answer?

Negative Bank Rates

Bank of Canada governor Stephen Poloz says he may consider following other nations into subzero bank-rate territory should we face an economic crisis. Would that strategy work? We’re not sure it would even matter.

 

Economics. Built on theories. And models. That’s all they are. If they were sound theories and models, maybe we could have predicted $30-a-barrel oil. Or a loonie that was destined to trade—again—at under US$.70.

 

Here’s another theory: Negative interest rates.

 

In the event of a crisis, Bank of Canada governor Stephen Poloz recently said he may consider following other nations into subzero bank-rate territory should we face an economic crisis. Is that strategy wise? More importantly, would it work?

 

On January 20, 2009, the Bank of Canada used its influence in an effort to boost the economy by dropping its rate 50 basis points to 1.25 percent. Six weeks later, the Bank dropped it another 50 basis points to .75 percent. It’s been hovering between those two numbers ever since and currently stands at .75 percent. Apparently, it hasn’t made much difference.

 

How would subzero rates help, you ask? Well, it’s a strategy that appears to be aimed squarely at the banks.

 

Currently, Canadian banks receive interest when they deposit money with the Bank of Canada. With a negative bank rate, the Canadian banks would have to pay a fee for that storage, something they would likely not want to do. Because it’s costly for the banks to store money themselves (storage fees, insurance, security), they would—presumably—find another way to use the money. Poloz assumes they would invest the money, something that would—again, presumably—stimulate the economy.

 

But would it?

 

The fact is, in the grand scheme of things, 25 or 50 basis points doesn’t really have much of a punch like it might have 20 years ago. Following the initial after-shock, marginal shifts appear to make little difference.

 

Negative interest rates might have a psychological impact, perhaps, and that may well get some banks spending. And that, in turn, might move things a little.

 

In our industry, lower interest rates might encourage borrowing and investments in real estate could get a boost. While rental rates could sag with economic pressure, renting and investing in such an environment would be attractive for foreign-based commercial entities.

 

But a subzero rate might also put even more pressure on the dollar—great if you’re an exporter, not so much if you have to buy goods on the international market.

 

There is some evidence negative interest rates might work. Switzerland, Sweden, Denmark and the European Central Bank have all used this tactic with varying degrees of success. More importantly, at least to the Bank of Canada, nothing catastrophic happened.

 

So, is this just another theory that may or may not play out in the marketplace? To be honest, we don’t know. And anyone who says they do is either psychic or wandering out onto a very long and thin limb.

 

 

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