European Central Bank Adopts Negative Interest Rates

Look for this to spread. For now the negative interest rate of -0.1% will only apply to bank reserves held at the central bank. The stated objective is to persuade the banks to reduce their reserves by lending more. 

In an earlier post, we explained that this move was under consideration not only by the European Central Bank but by most world central banks. Don’t be surprised if it spreads and eventually leads to negative interest rates for consumers too. Of course, interest rates are already negative for consumers in that they are less than the rate of reported inflation.

Think of these low rates for savers as a kind of tax, a tax aimed at the most responsible members of our society, the ones who are trying to put something away for their children’s education or retirement. Research also suggests that this tax is holding down, not stimulating, economic and jobs growth.

This move by the ECB is based on two particularly erroneous ideas. The first idea is that more borrowing and spending is always good for an economy. This is wrong because it completely ignores the quality dimension. Sound spending and investment is helpful; wasteful spending and investment just creates bubble and bust. When central banks force lending, they are just creating more waste.

The second idea is that Europe is at risk of falling into deflation (consumer prices falling) and that this would lead to depression. This confuses cause and effect. Depressions cause rapidly falling prices, not the reverse.

Moreover, gently falling prices are good for an economy. The middle class and poor especially benefit since they can buy more with limited incomes. The US experienced its best economic and jobs growth ever when prices were gently falling during the late 19th century and the period leading up to World War I. 

We have all experienced how beneficial it has been for computer prices to keep falling while quality improves. That is called productivity and should be the goal of every central bank. Instead, central banks do everything they can to keep unproductive firms and sectors alive and thereby throttle the economy.

What economic managers in Europe, the US, and elsewhere are doing to the middle class and the poor is tragic. People in the US may not be starving, but millions of lives are being blighted.

Hunter Lewis is co-founder of AgainstCronyCapitalism.org, co-founder and former CEO of Cambridge Associates, a global investment firm, and author of two recent books, Crony Capitalism in America 2008-2012 and Free Prices Now!, about the Fed.