By Joseph T. Salerno
In 2016, the Fed’s annual stress test on banks will include a scenario in which the interest rate on the three-month U.S. Treasury bill becomes negative in the second quarter of 2016 and then declines to -0.5%, remaining at that level until the first quarter of 2019. According to the Fed, “The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities.” In other words, including this scenario in its stress test is not supposed to signal that the Fed is contemplating adopting a deliberate policy of negative interest rates. It is simply testing the resilience of big banks in the face of a severe recession that precipitates a “flight to safety” which spontaneously drives rates on short-term Treasury securities into negative territory. Or so they would have us believe.
Recent remarks by those associated with the Fed, however, seem to suggest otherwise. For example, former Fed official Roberto Perli, now a partner at Cornerstone Macro LLC, commented “It doesn’t signal anything” about future monetary policy, but then added, it is “another sign that the Fed would not be entirely adverse” to reducing its target rate below zero if economic conditions should warrant. In mid-January, New York Fed President William Dudley denied that policy makers were “thinking at all seriously of moving to negative interest rates.” However, he conceded, “I suppose if the economy were to unexpectedly weaken dramatically, and we decided that we needed to use a full array of monetary policy tools to provide stimulus, it’s something that we would contemplate as a potential action.” Most tellingly, just this past Monday, Fed Vice Chairman Stanley Fischer gave a talk to the Council on Foreign Relations in New York in which he approvingly discussed negative interest rates in some detail. Because a speech by a Fed Vice Chairman sometimes turns out to be a bellwether of a radical shift in monetary policy–recall Bernanke’s infamous speech on deflation and unconventional monetary policy in November 2002–Fischer’s remarks are worth quoting:
[W]e believed that we could not get interest rates to go below zero. Well, it turns out that … four European and one Asian country have now done that. And how can you do that when currency has a zero rate of return? You can do it because it turns out that holding currency is not so easy. If you’re going to keep your billion dollars in currency, you’re going to have to find a place to store it, you’re going to have to insure it, and you’re going to have to have it guarded. And by the time that’s done … zero is no longer the lower bound. All those costs are the lower bound, and those costs seem to be significantly below zero in the sense that we have a Denmark and one other country having a negative 75 basis point interest rate, which worked. … So that idea is there. And that’s what they’re pursuing. And, you know, everybody is looking at … how that works. … [W]e have actual experience of countries that have used negative interest rates. … Countries that have used it continue to use it. They haven’t given it up. … So it’s working more than I can say that I expected in 2012…
And, lest we forget, Fed Chairman Yellen went on record as conditionally favoring negative interest rates as President of the Federal Reserve Bank of San Francisco in 2010:
If it were positive to take interest rates into negative territory I would be voting for that.