Bank balance sheets are not strong enough to cope with negative interest rate policy, one economist has warned.
David McWilliams, an economist writing for Woodford Investment Management, says the banking industry is still recovering from the financial crisis and the more recent China turmoil and is not stable enough to cope with negative interest rates.
“Unfortunately, the central assumption of using monetary policy to fight deflation is that the banks are in rude health and bank lending will be the engine of growth, stimulating the economy. Nothing could be further from the truth,” says McWilliams.
As a result of previous crises the private sector has too much existing debt and does not want to borrow, while the banks have too much bad debt and don’t want to lend, he says.
“Negative interest rates amplify this problem precisely because negative rates make fragile banks weaker, not stronger, undermining the very institutions which were supposed to be the foundation of the recovery,” he adds.
His comments come as Bank of England governor Mark Carney said the Bank would consider cutting interest rates, but ruled out negative interest rates.
“We have other options and would take very seriously the impact of negative interest rates on financial services and building societies especially,” said Carney, speaking to the Treasury Select Committee.
Instead, McWilliams recommends expansionary fiscal policy, so using more public money to invest in the economy, which he says “would be hardly revolutionary”.
“It’s been done before and it worked, it’s just out of fashion. More radical would be the use of ‘helicopter money’, which Jeremy Corbyn has called ‘QE for the people’,” he adds.
Helicopter lending sees central banks financing government spending or tax cuts directly, not via banks or markets.
“This creates new uncertainties, of course, not just over what policies central banks will choose to pursue, or when, but also over the differing extents that the major central banks will go to in boosting growth and spending,” says Andrew Humphries, marketing and communications director at St James’s Place Wealth Management.
“Moreover, a number of touted policy directions have not been tried before. Given ongoing debates about the impact of quantitative easing – very much a tried-and-tested approach – it is hard to predict how these new policies will play out in markets.