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Central bank of Sweden reduces interest rate to below zero, what are the consequences

Unthinkable became reality.

Central bank of Sweden reduces interest rate to below zero, what are the consequences
źródło: Flickr

Swedish central bank (Riksbank) has decided to lower its repo rate, at which they conduct money market operations to negative 0.1. It means that banks can borrow money from the central bank at zero, or even at negative interest rate. Decision was taken despite the fact that Riksbank forecast calls for higher economic growth and lower unemployment in 2015 and beyond. Additionally Riksbank embarked on quantitative easing (buying government bonds), which by now has become a standard monetary policy in many developed countries. So far only ECB and central bank of Denmark lowered deposit rates to negative, which means that commercial banks are punished when they deposit excess cash at the central bank. Riksbank did more, banks in Sweden can now borrow from the central bank at negative rate.

Those who are trained economists do remember that we used to teach students about lower bound and that interest rates cannot go below zero. Now they do. The goal of Riksbank is to accelerate the process of return of inflation to the central bank target of 2 percent.

Imagine that this process does not stop here, that inflation for many reasons remains in negative territory and that central banks reduce interest rates even further, to, say, negative 5 percent. In such circumstances banks will be able to borrow from the central bank at negative 5 percent, do nothing, and get 5 percent profit. Creditor will be able to borrow from the commercial bank at negative 3 percent, and if they borrow 100 mln, they will return a year later only 97 mln (5 percent minus bank margin). Those that save money will be punished, as deposit rate will also become deeply negative. If you save 100 mln, year later you will have, say, only 94 mln (five percent plus bank margin).

What are the consequences. In the finance course students learn about IRR (internal rate of return of a given project). Projects get funded only if IRR is above the cost of credit. But in this hypothetical case banks will fund projects that have negative IRR, say equal to negative 2 percent. Interesting, indeed, loss making projects, that take away value from the society, will be funded.

Such policy also means that savings are being confiscated. Those who worked hard in the past and made some money, those who save for retirement, will be punished. Such policy discourages hard work and saving and promotes reckless behavior.

I understand what is the central bank goal, to force inflation to return the central bank goal of 2 percent. But I do hope that the central bank is aware about the consequences and about pathological incentives created by such policy.

Kategoria: Gospodarka

Krzysztof Rybiński

Economy of the XXI century -

Professor Krzysztof Rybinski holds MA in computer sciences, and Ph.D. in economics. He has an extensive professional background. He worked as software engineer in Tokyo, director of the Soros Foundation programs in CEE, a consultant to the World Bank. He was chief economist and managing director at commercial banks. In 2004, he was appointed the Deputy Governor of the National Bank of Poland by the President of Poland and performed this function for four years until 2008. He was in charge of research, foreign exchange reserves management, payment systems, cash circulation management, monetary statistics and international relations. Under his supervision National Bank of Poland changed its investment strategy which resulted in additional one billion dollars profit for Poland. In 2004-2005, he was member of the EU Economic and Financial Committee, and in 2007-2008 a member of the Polish Financial Services Authority. In 2007-2008 he served as a World Bank alternate governor for Poland. He was also member of the supervisory boards of several financial sector companies (2008-2009) and Partner in Ernst & Young Poland (2008-2010). Since 2010, he has been Professor and President of Vistula University in Warsaw, which offers education to students from more than 30 countries. In 2012 he launched the investment fund called EUROGEDDON, its investment strategy assumes deepening financial crisis in the Eurozone. The fund launch was covered by Financial Times and CNN International.

Krzysztof Rybinski was economic advisor to several Polish governments. In the last few years he was a coauthor of country higher education strategy, e-government strategy and intellectual capital strategy.

Krzysztof Rybinski is author of numerous refereed papers in economics and (co) author of several books. In March 2012 ranking he was ranked the fourth best Polish economist by number of scientific citations. In October 2012 he received the business award of most respected Polish economist. He has also contributed hundreds of articles on economics and financial markets to Polish newspapers. He published in The Wall Street Journal, Financial Times and The Economist. He was the first senior central banker in the world to have started a popular and often quoted by media economic blog already in 2006.

Komentarze 1 skomentuj »

I wander why nobody is able to see an elephant in the room? The animal is big, is huge and is making all that terrible noise. But still - nobody can see it.

So, what is an elephant in the room? It is transfer of ability to create money, from political bodies like king or government, or parliament; to the private financial enterprises.

In the past, when goverment wants an inflation, then just issued a currency. Voila! But now, it can't! So it tries to do some strange and dangerous moves to achieve the same goal, more money in flow on market.

Am I right?

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