Central banks around the world are having a difficult time promoting economic growth, reaching target inflation or maintaining optimism among investors. However, many of the world's central banks operate under a negative interest rate policy (NIRP), considered an extreme measure to encourage spending and borrowing.

Banks Using Negative Interest Rate Policies

The Bank of Japan (BOJ), the European Central Bank (ECB) and many other minor central banks assess a negative interest rate on reserve deposits from member banks. A negative interest rate policy simply implies that banks are charged a fee for money on deposit, rather than receiving a net interest payment. The goal is to reduce the risk premium on marketable securities, which will lower yields on safe assets.

That part is working. If you adjust the nominal yield on a 10-year German bond for inflation, the real interest rate is approximately negative 0.08%. This means that if you invest in one of those bonds, you have to pay the German government for the privilege of lending money to it.

As of June 2016, there was approximately $8 trillion in government bonds trading at negative rates in global markets – more than the combined 2015 gross domestic product (GDP) of Japan and Germany, the third- and fourth-largest economies in the world, respectively.

A Stagnant Economy

The global economy is experiencing extremely slow growth in 2016, and prospects for 2017 seem bleak. An April 2016 survey by the International Monetary Fund (IMF) only forecast 3.2% growth for the remainder of the year. For advanced economies, such as the United States, projected growth was 2%.

The IMF identified several reasons for the poor economic performance, such as difficulties among the oil-exporting countries, turmoil in Latin America and China, serious recessions in Brazil and Russia, and disappointing potential from other low-income nations.

Even though the IMF identified accommodative monetary policy as essential and valuable, there are reasons to question the effectiveness of central bank policy. There is very little empirical justification for future stimulus efforts.

The Limits of Monetary Policy

In early June 2016, Mitsubishi UFJ Financial Group Inc. (NYSE: MTU) foreshadowed that it may withdraw as a primary dealer for Japan's government bonds (JGB). The move could be completed as early as July. Company officials are keeping quiet about the exit, but it is not a secret that banks would rather not hold JGBs when yields are below zero. Without member banks’ cooperation, the challenge for central banks should only become more daunting.

Torsten Slok, chief international economist at Deutsche Bank AG (NYSE: DB), told the Wall Street Journal, "I think we have reached the limit of what monetary policy can do." Slok pointed out that central bankers do not have ultimate authority over the decisions of individual buyers, sellers, borrowers and savers.

If true, and central bankers can’t use monetary policy to affect national or world economies positively during the prolonged slump, then it calls into question the underlying philosophies (and possibly even the existence) of monopoly banking authorities.

Why Negative Rates Fail

The concepts behind today's monetary policy are a combination of Keynesian and post-Keynesian macroeconomic theory. Central banks believe idle resources need to be sparked back into productive use. The normal remedy – lower interest rates through aggressive bond purchases – discourages savings and encourages borrowing. It also encourages investment in riskier assets, including stocks and commercial real estate. The track record is spotty, but that is the idea.

The goal with NIRP is to force commercial banks to loan out excess reserves. However, most banks have a shortage of creditworthy borrowers. Central banks are pushing for banks to lend at the same time that most debtors want to pay off their loans. Meanwhile, savers get pinched, and investors lose confidence.

Economists often blame recessions on insufficient demand. That is another way of saying that demand is misaligned with supply. No bond buyer or creditor benefits from negative interest rates, so the demand for such assets is likely zero. Forcing yields below their market rate only encourages a misalignment of supply and demand.

Under NIRP, the supply of safe, interest-bearing investments is too low. The supply of cheap loans is too high, as is the supply of loans taken out for risky projects. The results speak for themselves: assets are detached from the fundamentals, nonperforming loans are on the rise and confidence is sinking. It is very unlikely that future business earnings will justify high debt loads and inflated stock prices.

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