Why negative interest rates won’t save us

While the prospect of negative interest rates is hitting the headlines on a weekly basis, they’re simply the wrong choice – with limited impact and hidden risks. Instead, the Bank of England should be embracing more transformative monetary policy, and coordinating more closely with the Treasury to combat this covid-induced economic crisis. 

The Bank of England’s base interest rate – often referred to as Bank rate – determines the interest commercial banks receive for holding money at the Bank of England. Currently, it sits at just 0.1% –  the lowest it has ever been, but speculation is mounting that the Monetary Policy Committee will lower the Bank rate even further, below zero, into negative territory. This would mean that banks would get charged for keeping reserves at the Bank of England. Yesterday, the Bank took another step towards making this a reality as it sent a letter to banks asking them about their “readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration”.    

Cutting the base interest rate is generally expected to stimulate the economy but it’s a terribly blunt tool, as commercial banks do not always pass on interest rate changes to their customers, and consumers and businesses tend to base their consumption and investment decisions on other factors. Moving below zero is unlikely to be any different.

Negative interest rates could even have negative consequences. For example, arguments in their favour are sometimes used to intensify the war on cash, because their effectiveness is said to be dampened by savers flocking to cash. Therefore, proponents of negative rates have claimed that phasing out physical cash should be a priority. These arguments ignore the threats we’d face under a cashless monetary regime, such as financial exclusion of vulnerable communities who rely on cash, and a loss of privacy. 

Another issue is that negative rates hit small-time savers while running the risk of further boosting asset prices, thereby deepening inequality. Savers with little money in their accounts would face a significant barrier to accumulating wealth if they start getting charged on their deposits. In order to prevent savers from getting hit by negative rates, the Bank should implement a policy of dual interest rates, where the Bank keeps the base rate at or above zero but lends to banks well below zero on certain conditions. 

The very fact the Bank is considering negative interest rates is a sign of how the government’s wider economic response to COVID-19 is failing. The Treasury appears to be ideologically committed to responding to the crisis using underpowered and ill-suited policies, and the Bank is also struggling to come up with real solutions. As we face a second wave of the pandemic, we need bold and innovative action from our economic institutions. 

Since the very beginning of this crisis, we’ve argued that the Treasury and the Bank must work together to protect the most vulnerable, support a green transition, and restructure rather than reproduce failed economic systems. A negative interest rate will not achieve these goals. The Bank of England has far more transformative tools at its disposal and now is time to use them. These tools include: 

• A central bank digital currency which could be used to support businesses directly and provide citizens with a universal basic income. 

• Credit guidance, where the Bank of England influences where commercial bank lending goes, could be used to boost green economic activity. 

• Attaching social and environmental strings to the central bank’s corporate lending schemes would promote positive change across large companies. 

• Dual interest rates could support both borrowers and savers. 

• And last but by no means least, direct monetary financing could pay for government spending and thereby help prevent a return to austerity.

These are the kinds of policies we need from the Bank. Negative interest rates are at best a distraction, and at worst a bad idea.