What happens when interest rates hit zero?

Ross Greenwood speaks to ING Asia chief economist Robert Carnell after the Reserve Bank governor Philip Lowe has indicated what would happen when interest rates hit zero.

Ross Greenwood: Well, we are talking about the Reserve Bank. Now, the interesting part about the governor of the Reserve Bank, Philip Lowe. He’s the boss of the Reserve Bank, but he also is the chairman of a key committee of the Bank of International Settlements, the BIS. Now, the BIS was created in 1930 to effectively have coordination and cooperation amongst the central banks of the world. We’re talking here, the US Federal Reserve, we’re talking about the Bank of England, we’re talking about the Reserve Bank. In fact, 60 central banks own the Bank of International Settlements, that is based in Basel in Switzerland. He is the chairman of a committee that has been investigating the effectiveness of so-called quantitative easing.

Now, this statement has come out today from the VIS, but it’s the first time it shows that the Reserve Bank governor has been intimately involved in trying to work out what happens when your interest rate is at zero. Here’s just a little of what he said from this landmark Bank of International Settlements report today.

Philip Lowe:  The financial crisis created extraordinary challenges for central banks, and require new policy approaches as conventional tools run out of steam. Many central banks introduced unconventional tools like negative rights and asset purchases, having had limited experience with how they perform in practice.

Ross Greenwood: Limited experience in how they perform in practice. Now bear in mind, there are some who say there are dangers in going down this path. Indeed, if you consider that a man who was the treasurer of Australia, for my recollection was almost eight years, might have been six, is a former prime minister John Howard, considered one of the foremost prime ministers of his time in this nation.

Now, go back in August, he spoke the ABC at that time, and he really let them know his views about interest rates and whether the Reserve Bank really was going down the right road. Have a listen to this.

John Howard:  I’m not sure that there’s interest rate cut has been raising now. I think we’ve cut interest rates probably far enough already, perhaps too far.

Ross Greenwood: That was before the Reserve Bank cut interest rates again just a week ago to the cash rate of 0.75%. Okay, so let’s go back to Philip Lowe because again, it seems you get the sense that this is where the Reserve Bank is headed sooner rather than later. In other words, they going to try and go to some of these unconventional tools he called them, negative interest rates, asset purchases, all these types of things. What was the lesson that came out of this? Here’s Philip Lowe again.

Philip Lowe:  One key lesson is that the tools are most effective when used together with a broader set of policies like physical and prudential measures.

Ross Greenwood: Now we start to get a hint as to what he’s trying to say here That is if Philip Lowe assign to the government squarely, I can’t do this alone. You’ve got to come in with tax cuts. You’ve got to come in with infrastructure spending. By the way, you’ve got to come in with other policies that allow more lending to go through the community. That’s what’s going on. Anyway, let’s go now to the chief economist of ING Bank based in Singapore, Rob Carnell is on the line. Rob, many thanks for your time.

Interview with: Robert Carnell, Chief Eoconomist, ING

Rob Carnell: You’re welcome.

Ross Greenwood: Just in regards to this, you’ve heard the set up to that and what Philip Lowe has said and so forth. Is it inevitable that Australia goes down what he calls some of these unconventional monetary policy tools such as negative interest rates or maybe quantitative easing, printing money buying back bonds, or maybe buying assets off thanks to put more money into the community?

Rob Carnell: Well, I really do hope not. I think the problem is, if you look around the world that the central banks are just still using these policies, the ECB will be a good one, the Bank of Japanwould be another. A very clear lesson you get from this as it simply doesn’t work. In fact, I think there’s even no argument that as you start pushing, interest lower and lower.

I’ve got a gut feeling that once they drop below about one, where the Reserve Bank cash rate is right now, it can even start to have negative consequences to the point that you’re completely in contrast to what economic theory would suggest that actually, when you cut rates that low, people actually save far harder and invest far less, rather than doing what’s supposed to happen. They go out and start spending the money and driving the economy forward.

The only thing it really seems to do is push asset prices up. That’s great news if you own them, but then for most populations, the majority of the population doesn’t have too much of that yet excuse in inequality and it’s just not a great idea. It’s very difficult to pull yourself back from these policies also, once you start doing them. A litany of reasons why I’d hope that Australia doesn’t go down this route.

Ross Greenwood: Okay. The interesting part about this and you raise one issue, and that is about business confidence. The net business confidence survey, which the Reserve Bank watches very closely is out today. Guess what? It’s deteriorated, even in the face of an interest rate cut just a week ago. That again, you wonder about the messages that are being sent out. Because generally, when interest rates are being cut, the economy is very, very weak. This, as I say, I think, is sending out a mixed message.

Rob Carnell: Yes, I think it is. It’s sending out a message that the RBA isn’t particularly confident about where the economy is going. We’ve heard from Governor Lowe about the gentle turning point that he thinks the economy at. I think he’s got some that there’s a merit in that argument. If you look at a lot of the macro data, it doesn’t look too bad, but perhaps these very low-interest rates, the further cuts that they actually make firms to go out and invest.

You got an awful lot of other stuff going on besides the monetary policy, the interest rate environment. The ongoing trade war, for example, is a major negative working on a lot of businesses around the planet. You got all sorts of sparks going on in terms of what’s happening to global technology as well, nobody really wants to get too stuck into enrolling 5G. When that comes on stream, there’s gonna be tons and tons of spending. People just don’t really want to commit right now, too much uncertainty.

Ross Greenwood: The one thing that you’ve made the observation of there, and a lot of people are going to think about this, if all of a sudden you’ve gone out, getting used to the idea of interest rates at 2%. Of course, the likelihood is now that the Reserve Bank, central banks around the world can’t raise interest rates quickly, not for a long time, potentially years. The main reason is if everybody has geared themselves up, and businesses have geared themselves up according to where the asset values and according to where the interest rates are right now, it could be a catastrophe if central banks suddenly have to reverse this position and raise the interest rates very quickly.

Rob Carnell: Yes, that becomes astonishingly difficult. It has a silver lining to this. It really isn’t the silver lining is that the environment doesn’t look as if central banks will be in a position to be able to put rates up very quickly, anywhere. That does mean that we’re really looking at an environment where perhaps for a very long period, we’re looking at incredibly low nominal interest rates.

While that might sound quite good, if you’ve been used to paying quite a lot of money on it on a mortgage, and suddenly that’s dropping a little bit, think about all those people who are saving for retirement. It’s astonishingly helpful and the market delivers you 2% or 3% compound interest year after year, and then can actually pay you an income on the money that you eventually accrue. Half a percent or 0.05%, which is about as much as you get off most retail establishments these days. You’re not getting paid in income and you basically save what you got in the bank if you’re lucky and no more, that’s it. You’re not going to retire comfortably on that.

That becomes very, very difficult for people when they’re thinking about, “How do I actually have a comfortable retirement? How do I save up the school fees for university?” All those other things that people save for. Suddenly you got to save that much harder to get there because the market ain’t helping you.

Ross Greenwood: I’ll tell you what Rob Carnell, great to have you in the program. That is the reason why you need to be interested when this talk goes to quantitative easing in zero or negative interest rates because the consequences for you as an individual and,or a business are profound and will be long-lasting, there is no doubt. Rob Carnell, chief economist at ING, based in Singapore. Rob, we’ll talk again very shortly.

[music]

Image source: 2GB

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