In theory, negative interest rates would motivate more people and businesses to borrow money, which should stimulate the economy. Critics argue that negative rates would penalize people trying to save money, as well as the big banks by forcing them to make unprofitable loans.
Researchers for the St. Louis branch of the Fed wrote in a report late last month that the combination of “aggressive fiscal and monetary policies is necessary for the United States to achieve a V-shaped recovery.”
Negative rates and more fiscal stimulus could lift economy
Wen and Reinbold argue that negative rates may need to remain in place for years in order to be fully effective.
“These policies also need to continue even when the crisis is about to end to provide a further boost, leading to a more robust recovery,” they wrote, adding that there really needs to be both negative rates and more federal government spending. The Fed can’t do it alone.
“Aggressive monetary policy — such as negative interest rates — may be ineffective on its own without aggressive fiscal stimulus,” Yi and Reinbold wrote.
Powell has called for more fiscal stimulus, but he has stopped short of advocating for negative interest rates. There are good reasons for that.
There are also legitimate concerns that negative rates will severely hurt profits for big banks in the United States. Rates below zero would squeeze the margins of banks’ lending arms. That might cause them to lend less — which could be catastrophic for the economy.
Does Fed still need to be this aggressive after strong jobs report?
Some economists are once again talking about the possibility of a quick and steep V-shaped recovery.
The odds are still against a rate hike this year, but some experts say the Fed doesn’t want to be trapped in an environment where it has to keep rates this low for as long as did last time around.
Covid-19 still poses a major public health risk, especially as economies reopen, and a resurgence of cases could deal even more blows to the economy and markets.
Negative rates are probably a last resort for the Fed. But there could be a need for more unconventional moves by the Fed chair if the recovery is jeopardized.
“Powell has signaled that negative interest rates are not in the cards right now,” said Steve Rick, chief economist at CUNA Mutual Group, in a report. “However, if a second wave of the virus hits later this year and the economy takes another fall before it can even get back up on its knees, more drastic monetary measures may be necessary.”