02/08/2024
Are we looking at an end of the era of negative interest rates and will they ever return? Have these unconventional measures of some monetary authorities from around the world achieved their goal? For me, these were never complex questions and I have always responded to them very openly and sincerely.
I do not want to, nor will I ever be able to accept, that money is not employed to perform one of its basic roles – earn through the institution of savings and the concept of interest. The opposite approach, I am convinced, violates the basic postulates of economics, the knowledge about the time value of money and the fact that when you lend money to someone, he should return the loan, along with the agreed interest. Although there have been cases in the world, in the era of negative interest rates, that the person who borrowed money even received (instead of paying) remuneration, while the depositor had to pay the bank for withdrawing the amount he deposited – I refused to accept as normal that money spends (instead of earns) for you. That is why I did not allow any bank in Serbia to apply a negative interest rate to client deposits, especially savings ones, which, as a rule, in addition to the return of the principal, also guarantee interest, which must be positive. Negative interest rates have been a controversial topic in the world of economics and finance in the past decade. In an attempt to stimulate economic growth and eliminate the risks of deflation, central banks worldwide have implemented aggressive measures to relax monetary conditions. In some economies, this also resulted in negative interest rates. We cannot disregard positive aspects of the fact that EURIBOR rates remained in negative territory for seven years (2015–2022) for users of euro-indexed loans with the variable interest rate, especially housing loans and especially users who took their loans before the rates entered negative territory. However, the interest rate as a whole has never entered the minus zone, nor would we allow it, because that calls into question the basic functions of money, and that was and remains unacceptable for Serbia. As we can see today – not only for Serbia. The newly emerged environment in the financial market, with rates in negative territory, threatened to undermine some important categories in the macroeconomic framework. The most important concept is savings, which is crucial for normal functioning of the economy and financial markets, as it is one of the basic sources of financing credit and economic activity. In a zero/negative interest rate environment of the past decade, savings were discouraged, and the deposit potential sought alternative ways to earn, which created inflationary pressures even outside the real flows – in the segment of the real estate market and/or financial markets that grew at significant rates. The negative consequences also reach deep into the basic postulates on which financial markets traditionally rest. Interest rates’ entry into negative territory also disrupted the valuation process of key financial instruments. Economist Mohamed El-Erian pointed out that negative interest rates are a sign of central banks’ desperation, not a solution to economic problems, while Nouriel Roubini called them a dangerous experiment with unknown consequences. In the opinion of many experts, the environment of extremely low and/or negative interest rates belongs to the past. Furthermore, even the structural factors of the global inflationary outlook do not indicate that such environment might return in any short/medium-term. As the three-year episode of elevated inflation, initially caused by supply-side factors, has calmed down, we have been functioning in an environment of “expensive money”, and globally elevated interest rates. As a precaution, in order to moderate a potential inflationary influence of demand-side elements, central banks, even those which embarked on their monetary policy easing cycles, will hold interest rates higher for longer. It seems that the global economy is moving towards a new, so far unexplored field, where the inflationary impact of the so-called secular (long-term) factors, such as demographic changes (global population ageing), energy transition, climate change, deglobalisation etc. could play out. These factors could, ceteris paribus, mean that in the next decade the focus of central banks will be more on a prudent approach of assessing the risk of increased inflation dynamics, in contrast to the decade preceding the pandemic, when leading central bankers were focused on the risks of deflationary movements, creating an environment of ultra-low interest rates. One of the prominent examples of negative interest rates, and due to the degree of integration with our economy, the most important for us – was seen in Europe. The European Central Bank (ECB) implemented the negative interest rates policy in 2014. The ECB hoped that negative interest rates would encourage banks to lend more money to businesses and consumers, thereby boosting economic activity and inflation, which had been very low for a long time. However, the results have been mixed, at best. While some European countries saw a slight uptick in economic growth, inflation remained stubbornly low for years, and many banks struggled to pass negative rates on to their customers. Apart from the ECB, in Europe, the central banks of Switzerland, Denmark and Sweden have also turned to such measures.
The Bank of Japan also adopted the concept of a negative interest rate as part of its aggressive monetary policy in its long-standing battle against deflation. However, the results were disappointing, with inflation remaining significantly below their 2% target.
On the other hand, the United States largely avoided negative interest rates, with the Fed opting instead for more aggressive unconventional monetary policy tools such as quantitative easing (QE) during the financial crisis. However, as the US economy faced challenges such as the COVID-19 pandemic, there were calls for the Fed to consider negative interest rates as a means of stimulating the economy. Nevertheless, the Fed’s officials did not allow cuts of interest rates and their entry into negative territory, partly due to concerns that it would not be consistent with US laws and partly due to worries about the effectiveness and unwanted consequences of such a policy. Former FOMC Chairman Ben Bernanke argued that negative interest rates create moral hazard by encouraging excessive risk-taking. His successor Janet Yellen warned that they punish savers and disrupt the financial system, leading to unforeseen consequences. I have always shared this view and therefore did not allow any savers in Serbia to be exposed to such unnatural conditions. Looking back, it is a big question whether negative interest rates have achieved their intended goals in the currency areas where they were introduced. Despite years of ultra-low and negative interest rates, many central banks struggled to reach their inflation targets. Quite the contrary, some argue that negative interest rates may have had the opposite effect, leading to deflationary pressures and slowing economic growth. At the heart of such views is the fact that banks preferred to deposit their funds risk-free (albeit at a cost) with central banks rather than engage them (with some risk) in lending and economic activity. As a result, there is a growing opinion that negative interest rates may not be a cure for low inflation and economic stagnation as central banks had hoped. Another finding, particularly important for central banks, which was highlighted as the first conclusion of a working paper by the World Bank’s researchers on the implications of negative interest rates, is that the implementation of such unconventional measures limits the effectiveness of monetary policy.
Therefore, it is not surprising that negative interest rates and a series of unintended consequences their application caused, have raised concerns among policymakers and economists. A conclusion from a well-known OECD working paper showed that negative interest rates in the euro area threatened the profitability of banks, therefore limiting the available capital necessary for sustainable credit growth (which contrasts with the expected effects of negative rates). Furthermore, several scientific papers have shown that lending activity was weaker in countries with negative rates compared to those that did not resort to such measures, due to pressures on banks’ net interest margins. In Serbia, the lending dynamic during the stated period was sound. From 2015 onward, i.e. during the period of negative interest rates in the euro area, credit activity in Serbia grew each year at positive average rates (with an ongoing positive trend), despite the fact that interest rates were positive.
One of the repercussions of negative rates is the generation of asset bubbles in financial markets due to changes in investors’ behaviour. Amid very low interest rates on safer assets (such as government bonds), investors are forced to increase their exposure to riskier assets, such as real estate, shares and corporate bonds of lower quality companies, thus generating upward pressures on the prices of such assets. Hence, in the previous years, despite pronounced global uncertainties, we witnessed a continuous record breaking in stock exchange indices and real estate prices. Valuation distortions were also present in the area of bonds, as indicated by an increasing volume of debt (bonds) in the world, carrying a negative rate of yield to maturity and reaching its maximum аt the levels of over USD 18 trillion (a thousand billion) in the period after the outbreak of the pandemic-induced crisis. Though negative interest rates were initially seen as an innovative tool and a step towards increasing central banks’ room for manoeuvre, with a view to stimulating economic growth and fighting low inflation – it seems that they did not manage to achieve the desired results, causing also certain side effects. I will paraphrase John Maynard Keynes and say that “when facts change, the approaches (of central banks) also change”. Challenges we are facing today require the adjustment of the monetary toolkit in some other direction, and for this reason the topic of negative interest rates is currently not on the agenda. Whether it will ever be, the time will show as one can hardly say that something “will never happen again”. Globally, it may not be anticipated any time soon, but in Serbia, while I am the Governor, there will be no negative interest rates, as my understanding of the essence of the role and function of money is not changed. Our experience from the previous two decades testifies to the need for central banks to be flexible, innovative and proactive. However, I would add they also need to be both more cautious and more balanced, which is the approach of the National Bank of Serbia. We have never blindly followed the decisions of the most influential central banks. Rather, we designed our own tailor-made solutions to the challenges of our specific financial system. And we will continue to do so, in favour of stability of the domestic financial system and our citizens.
Governor's Office
