To Impose or Not to Impose—The Dilemma of Negative Interest Rates and the Rise of Bankocracy

By | July 10, 2020

As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the “GIFT.” Big numbers!

Donald Trump


On June 10, 2020, the U.S. Federal Reserve (‘the Fed’) voted to keep interest rates near zero in the wake of the COVID-19 pandemic and hinted that rates will remain unchanged until the U.S. economy recovers from the pandemic.

The Fed’s decision on interest rates came amidst an ongoing discussion of whether the Fed should resort to negative interest rates to curb the economic damage ensuing from the pandemic. Earlier, in May 2020, the Fed Funds futures market predicted negative interest rates in the U.S. by April 2021. And in mid-June 2020, Bloomberg advised its users to prepare for negative interest rates.

If the U.S. adopts negative interest rates, it will join the ranks of the European Central Bank (ECB), Denmark, Japan, Sweden, and Switzerland. But the experience of these negative interest rate adopters is far from glowing. The ECB set a negative interest rate for the first time in 2014 to help recover from the economic collapse that started with the global financial crisis in 2008. Since then, European banks have lost about 50% of their value and a recent ECB review concluded that under negative interest rates, bank lending increased by less than 1% annually. Forbes reports that negative interest rates are destroying Europe’s finances and increasing demand for cryptocurrency. And former Treasury Secretary Larry Summers found that negative interest rates in Sweden decreased economic output.

With negative interest rates producing such lukewarm effects, why does the market expect negative interest rates by next spring? And more fundamentally, what do the increasing calls for negative interest rates say about the state of our democracy in the U.S.?

The Economic Theory of Negative Interest Rates and Its Benefits

Historically, cutting interest rates has been central bankers’ primary tool for combating recessions. For example, from September 2007 to December 2008, the Fed tried to stave off the Great Recession by reducing interest rates from 5.25% to zero. According to traditional economic theory, lower interest rates promote more borrowing and spending, which in turn leads to lower unemployment and higher inflation.

But in the aftermath of the 2008 financial crisis, the historical link between inflation and unemployment has broken down. Immediately before the COVID-19 pandemic, unemployment was at 3.5%, but inflation was still running below the Fed’s goal of 2%. When the Fed raised interest rates to just 2.5% in December 2018, markets fell, forcing the central bank to reverse course less than eight months later. Accordingly, the Fed has continued to keep interest rates low; on the eve of the COVID-19 shutdowns, interest rates were still below 2%.

In response to the pandemic, the Fed has injected trillions of dollars into the economy to prevent it from slipping into a severe recession. Critics argue that this tsunami of easy money, such as quantitative easing and repo operations, encourages lending but not spending, while also amplifying the U.S.’s inequality problem. Therefore, there is an alternative view that the U.S. should consider imposing negative interest rates. Already, economists at the Federal Reserve are calling for negative interest rates to be part of a COVID-19 recovery plan.

There are several potential advantages of adopting negative interest rates. First, negative interest means that the interest rate will fall below 0%, thereby penalizing savers. This should encourage banks to lend – as opposed to holding reserves at the Fed – and consumers to borrow and spend, which would stimulate economic growth.

Second, from the U.S. perspective, negative interest rates are likely to weaken the dollar and strengthen U.S. exporters. Over the past year, bipartisan voices have advocated for actively managing the dollar to boost exports. In fact, the policy of weakening the dollar has rare mutual support from both President Trump and Senator Elizabeth Warren. Further, weakening the dollar through negative interest rates would likely avoid the international legal problems associated with currency manipulation.

Lastly, negative interest rates would help developing countries. These countries face serious debt problems that the COVID-19 pandemic has exacerbated, with Fitch Ratings predicting that 2020 will be a record-breaking year for sovereign defaults. By adopting negative interest rates, the U.S. could help the world avoid this wave of sovereign defaults. Negative interest rates in the U.S. would make developing countries’ debt more attractive to investors and ease their debt burden by weakening the dollar.

Drawbacks of Negative Interest Rates

Nonetheless, negative interest rates are strange, and this strangeness can hinder their effectiveness. Sweden’s central bank abandoned negative interest rates in part because the public could not understand such an alien policy.

The strangeness of negative interest rates becomes especially apparent when commercial banks impose these rates on retail depositors. Although banks are reluctant to impose negative interest rates on retail depositors, a policy of long-term negative interest rates may leave banks with no choice but to pass these negative interest rates onto their customers. Major Swiss, Danish, and German banks have already done so, and the majority of German banks now impose negative interest rates on their corporate clients.

However, this comes with a drawback—if banks impose negative interest rates on depositors, then depositors may withdraw their money and hoard cash. Evidence from Sweden suggests that negative interest rates reduced bank deposits. And the risk of cash hoarding is particularly acute in the U.S., where cash remains the most used payment method. Even economists who support negative interest rates recognize that cash hoarding is the major impediment to successfully implementing a negative interest rate policy.

And preventing cash hoarding is no easy task. One of the government’s primary tools to prevent cash hoarding is phasing out large-denomination banknotes, but India’s recent experience shows that withdrawing large banknotes may cause severe economic disruption. Some supporters of negative interest rates have even suggested abolishing paper currency altogether! A less radical way to prevent cash hoarding is creating an exchange rate between paper money and electronic deposits that favors electronic deposits.

Beyond banks and depositors, negative interest rates also threaten money market funds. With interest rates currently near zero, U.S. money market funds must waive fees so as to avoid giving their clients negative returns. Hundreds of money market funds are currently yielding zero or a measly 0.01%, and a negative interest rate policy could deal a death blow to these funds.

Pension funds may be another casualty of negative interest rates. Extremely low or negative returns could force pension funds to cut benefits. And cutting benefits could pressure workers to save more for retirement, which would lower aggregate demand and thereby weaken economic growth.

Rise of the Bankocracy

Ultimately, the cons of negative interest rates likely outweigh the pros. But negative interest rates themselves reflect a deeper problem: democratic governments’ increasing reliance on technocratic institutions to solve serious social and economic problems. Political scientists, law professors, and judges are sounding the alarm about creeping juristocracy: democratic nations ceding more and more power to the courts. A similar phenomenon is occurring with central banks. Rapidly, with little or no public debate, democracies are ceding power to central banks, effectively creating a “bankocracy.”

Professor Edward Goldberg of New York University recently described the Federal Reserve as a “hegemon . . . empowered to make the rules of the game.” With a current balance sheet of $7 trillion that may grow to $10 trillion by year’s end, the Federal Reserve undoubtedly makes the rules for the global economy. In the wake of the COVID-19 pandemic, the Federal Reserve now buys ETFs and corporate bonds, lends to state and local governments, supports public transit, purchases trillions of dollars’ worth of Treasuries and government-backed mortgage securities, pours trillions into the repo market, makes loans to small businesses and nonprofits, resurrects companies from bankruptcy, rescues fallen angels, and provides dollars to central banks across Europe, Asia, Oceania, and the Americas.

The Fed’s newfound power poses problems for the institution itself, as Chairman Powell has recognized: “What I worry about is that some may want us to use those powers more frequently, rather than just in serious emergencies like this one clearly is.” And by stepping out of its traditional role, the Federal Reserve threatens its own independence.

Further, central banks are not able to solve all of society’s economic ills, nor should they be expected to. The limits to central bank power are especially pronounced now, in the era of perpetually low interest rates. With little ability to lower interest rates, the New York Times has generously described the Federal Reserve as “low on firepower.” Less generously, but perhaps more accurately, the Financial Times has concluded that “monetary policy is broken.”

Paradoxically, it is the “broken” nature of conventional monetary policy that has propelled the Federal Reserve into its unprecedented position of power and encouraged discussions of negative interest rates. With interest rates at historic lows and partisanship at historic highs, the Federal Reserve would have to expand its toolkit if it is to run the economy, while elected leaders are happy to shirk responsibility by handing over more power to the Federal Reserve.


In a world of perpetually low interest rates, it is understandable that some would call for negative interest rates. After all, a policy of negative interest rates follows the traditional monetary policy logic of lowering the cost of borrowing to stimulate the economy. Nevertheless, there is no convincing evidence that negative interest rates work.

Yet the biggest problem with a negative interest rate policy is that it would continue the Federal Reserve’s practice of carrying out allegedly “extraordinary” measures to stimulate the economy. Monetary policy has its limits, and it is time we recognize those limits.          

Ultimately, responsibility for a healthy and equitable economy rests on the shoulders of Congress. It is time for democratically elected leaders to step up to the plate and take responsibility for the economy that they have been chosen to lead.


Chris Smith  is a recent graduate of Duke Law (J.D. ‘20) who will soon begin working for a major international law firm.

Sangita Gazi is a recent graduate of Duke Law (LL.M. ’20) who will soon begin a PhD in Law.

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