A top economist has warned that when the next major recession or global financial crisis materialises, central banks could be more likely to introduce negative interest rates as part of their economic policy.
Kenneth Rogoff, a leading economist at Harvard, has stated that he believes during times of future financial peril, central banks will turn to negative interest rate policy rather than renewing quantitative easing as a preventative measure.
During the last global financial crisis, central banks across the globe placed their trust in money creation to stimulate the economy, combined with a wide-scale reduction in interest rates.
However, Mr Rogoff believes that this policy will not be a staple of future recessions, and that central banks should start preparing themselves now for a future introduction of negative interest rates.
Banks are Nervous About Negative Interest Rates
Traditional economic mantra has made central banks nervous about the idea of implementing negative interest rates.
It has been believed that such a policy would lead to savers withdrawing their money from financial institutions and storing it at home, or in other financial programs. If this fear was to materialise, then negative interest rates would surely only compound any recession or financial crisis.
However, Mr Rogoff believes that this is a fear that should be consigned to the past.
He believes that the growth of electronic payment methods and the decreasing frequency of cash transactions facilitates a negative interest rate policy like never before.
In his new academic paper, Mr Rogoff stated: “It makes sense not to wait until the next financial crisis to develop plans and, in any event, it is time for economists to stop pretending that implementing effective negative rates is as difficult today as it seemed in Keynes’ time.”
Larger Denomination Notes Should Be Removed from Circulation
He also believes that as a complimentary measure to a negative interest rate policy, central banks should remove the larger denomination notes from circulation to prevent the chance of savers hoarding their money in significant amounts.
This further ties into his idea that cash transactions are on the wane, and the cash transactions that do still occur are of a much smaller amount than at any point in the past.
Therefore, with so much of the modern financial economy based on electronic payments, Mr Rogoff believes that it would be much easier for central banks to implement a policy of negative interest rates to help combat any potential recession or financial crisis.
The trends of recent recessions show that central banks around the world drastically cut interest rates in an attempt to alleviate the economic consequences.
However, with interest rates in the developed world being lower than ever, Mr Rogoff believes that any future financial crisis will leave central banks scratching their heads at what is the best policy to follow, unless they incorporate the idea of negative interest rates into their economic armoury.
Other policies, such as quantitative easing and forward guidance have been attempted around the world in recent recessions, but with very mixed results.
This leads Mr Rogoff to his conclusion that, in the future, we should all expect to experience a period of negative interest rates.
Only time will tell when the next recession will hit, and how severely it will impact the economy, but one thing is for certain; Mr Rogoff is spot on when he says central banks should start their contingency planning as soon as possible.