Posted by: Simon Lack | August 30, 2012

The Strange Effect of Negative Interest Rates

Interesting piece from NY Fed on negative interest rates and the possible behavioral changes they would cause. If banks were charged for leaving deposits with the Fed, they would in turn charge customers for holding balances. It could cause all kinds of odd outcomes; naturally individuals would hold much more cash, but for corporations and institutions that wouldn’t be feasible. It could cause bills to be paid early, or where the recipient is highly creditworthy paid in advance. Many more certified checks could wind up being issued – you could issue one to yourself to avoid bank charges on the deposited cash. And special purpose banks might spring up who would hold deposits in the form of cash in a vault (as opposed  to make loans).

It all illustrates the difficulties presented by deflation, which is why we can expect the Fed to use all means available to avoid such a situation.

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