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Remarks by Hervé Hannoun, Deputy General Manager, Bank for International Settlements, at the Eurofi High-Level Seminar, linked to negative policy interest rates, and/or negative central bank deposit rates.
The policy of prolonged ultra-low, or negative, interest rates relies on transmission channels with uncertain effectiveness and potentially serious unintended consequences. For central banks, such policies raise the risk of financial dominance, exchange rate dominance and fiscal dominance – that is, the danger that monetary policy becomes subordinated to the demands of propping up financial markets, massaging the exchange rate downwards, and keeping public refinancing costs low in the face of unprecedented public debt burdens. These risks have been present before, but never so acutely as today.
Meanwhile, financial markets continue to set the stage for policy deliberations by fuelling expectations for continued, and additional, monetary accommodation. Behind the enthusiasm of market participants for extreme monetary policy, of course, lurks the fear that asset prices might collapse when the music of monetary easing stops. No doubt, this helps explain why the mainstream view in financial markets is that central banks should never surprise the markets and should act in a predictable way, which is interpreted to mean in line with market expectations. In this light, the Swiss National Bank’s decision to discontinue the exchange rate cap on the Swiss franc was not only justified in itself, but also very important from the broader perspective of the central bank community. By this decision they reclaimed the right of central banks to surprise the market, and to reject any form of “financial dominance” over monetary policy. Only a timely exit from UMP will deliver overburdened central banks from the “three dominance risks”.
In the last analysis, the debate on ultra-low policy rates comes down to a trade-off between the short and the long term. To quote Masaaki Shirakawa, former Governor of the Bank of Japan: “Monetary policy can bring forward future demand to today by engineering lower real interest rates. But, when tomorrow becomes today, the economy is faced with lower demand, which necessitates bringing forward demand from the day after tomorrow.” Borrowing growth from the future is not sustainable.