Cooking the Books II: Negative interest rates
Last month the question of ‘negative prices’ came up. Now, there is talk of ‘negative interest rates’. This would be where the lender, instead of receiving at the end of the loan period more than they lent, would end up with less. It is hard to imagine a bank lending on such terms. As interest is the source of income which, after paying their expenses, bank profits come from, this would be to run at a loss. The bank, instead of increasing its capital in accordance with the economic logic of capitalism, would see it diminish.
This, however, has often been the fate of other lenders, especially small savers. It occurs when there is inflation and the price level rises by a higher percentage than the rate of interest. In that case, at the end of the loan period the purchasing power of the amount lent will have fallen; the amount by which it has fallen could be described as ‘negative interest’. Governments have been known to deliberately inflate the currency in order to reduce their debt in real terms. However, this can’t be done too often as lenders will soon cotton on and lend only if the rate of interest is tied to the rate of inflation (‘indexed’).
Current talk about negative interest rates is not about this, but about the Bank of England fixing what used to be called the Bank Rate (but is now the ‘base rate’) at a minus figure. This would not be much of a change as the rate is currently only 0.1 percent (1p on every £1,000 lent). The Bank Rate is what the Bank pays commercial banks on what they deposit with it. This is therefore a policy aimed at banks, to discourage them from holding money and make them lend more.
The banks are sceptical as they know from experience that bank lending is not governed by the supply of money to lend. There are plenty of entrepreneurs who want money for some project but banks will only lend for projects that they consider viable, i.e., will turn out to bring in a profit sufficient to repay the loan with interest. This depends on the state of the economy and the general prospects for profit-making; in other words, on the likely rate of profit. It is this rate, not the rate of interest, that drives the capitalist economy. Which is why monkeying about with the rate of interest over the past decade or so has failed to stimulate the economy (but only the stock exchange).
A negative Bank Rate would also make banking less profitable. As Stephen King, HSBC’s Senior Economic Adviser, reflecting his paymaster’s point of view, put it in the Evening Standard (1 June):
‘Banks traditionally make money through the “spread” between the interest rate offered to depositors and the interest rate demanded from borrowers. With negative interest rates, banks would effectively have to take money out of savers’ bank accounts, a deeply unpopular outcome. In the face of this banks might end up letting lending rates fall more than deposit rates, in effect cutting the “spread”. That, however, would lower bank profitability and reduce the volume of lending, the opposite of what policymakers would be hoping for. Borrowing costs would be lower, but a dwindling proportion of people would actually be able to get access to credit.’
He went on to add that, with inflation still happening even if at a low rate, reducing the amount paid to savers would reduce the purchasing power of their savings as in the first type of ‘negative interest’.
Note the matter of fact way in which King writes about a bank’s income coming essentially from the difference between the rate of interest it pays to those it borrows from (depositors and others) and the higher rate at which it lends money. No nonsense here about banks having the power to create out of thin air the money they lend.