There has been a lot of talk about the excess reserves that are piling up at the Fed as banks refuse to lend the money the government is throwing at them. If the banks don’t lend, the economy won’t recover, and the Fed will have trouble generating the inflation needed to lessen the burden of our debt binge.
Other countries are having the same problem. And now one, Sweden, is addressing it by introducing something that has never been tried before: negative interest rates designed to penalise banks for keeping excess reserves.
If the Swedish model works, other countries may soon follow suit…
Andrew Ward and David Oakley, FT: For a world first, the announcement came with remarkably little fanfare.
But last month, the Swedish Riksbank entered uncharted territory when it became the world’s first central bank to introduce negative interest rates on bank deposits. Even at the deepest point of Japan’s financial crisis, the country’s central bank shied away from such a measure, which is designed to encourage commercial banks to boost lending.
But, as they contemplate their exit strategies after the extraordinary measures of the past two years, central bankers will be monitoring the Swedish experiment closely.
Mervyn King, the Bank of England governor, has hinted he may follow the Swedish example as the danger of a so-called liquidity trap, where cash remains stuck in the banking system and does not filter out to the wider economy, is an increasing concern for the UK.
Hoarding is exactly what happened in Japan earlier this decade when the Bank of Japan implemented quantitative easing between 2001 and 2006.
Japanese banks refused to lend, in spite of central bank stimulus, because of fears over the dire state of the economy.
If this continues to happen in other economies, central bankers may be left with little choice but to follow the Swedish example. John Wraith, head of sterling rates product development at RBC Capital Markets, says: “The success of the UK’s quantitative easing experiment hinges a lot on whether the banks will use the extra money they are getting for lending to individuals and businesses.
“If there is no sign of this over the next few months, then the Bank of England might consider a negative interest rate. In essence, it is a fine on banks that refuse to lend.”
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