Hoping to kick-start European economies, the European Central Bank took the extraordinary step two years ago of lowering one of its key interest rates to below zero. The idea was to discourage banks from stashing their money in the central bank by charging them a modest rate for doing so. Since the banks would lose money rather than earn interest on their deposits, it was hoped they would be prompted instead to make more loans at lower rates to businesses and consumers.
It hasn’t worked very well. As many experts predicted at the time, the policy has had only a modest impact on growth. It is also increasingly clear that pushing rates down further wouldn’t help much and could, in fact, increase risks to the global financial system.
The European Central Bank, or E.C.B., sets monetary policy for the 19 countries that use the euro. In June 2014 it became the world’s first major central bank to adopt so-called negative interest rates. Monetary officials in Denmark, Switzerland and Sweden adopted similar policies in the following months; the Bank of Japan joined them in January.
Negative rates have helped to push down the cost of borrowing, but that has not provided a big lift to the Euro area. The E.C.B. expects growth of 1.6 percent this year, about the same as last year. This is not surprising, because lower rates don’t address the real economic problems of many European countries: weak consumer demand and weak business investment. Companies are less likely to borrow for new investments when demand for their goods and services is not increasing — even if the cost of borrowing is cheaper than ever.
Of course, growth might have been even lower without negative interest rates. But there are limits to the benefits of such unconventional monetary policies. It would be far better if European governments used fiscal policy to increase demand by investing in roads, bridges, railroads, ports and other infrastructure. Government spending would create jobs and stimulate economic activity, and would not cost much. Bond investors are willing to lend money to the German government for 30 years at a rate of just 0.38 percent; in France, the rate is only 0.878 percent.
Meanwhile, continuing to rely on negative rates could be dangerous. The worry among many experts is that banks, institutional investors and even individuals desperate for higher returns might be seduced into taking foolish risks. They might also be tempted to make big investments overseas, driving up the price of stocks and bonds in the United States and Asia and creating bubbles that expose the global financial system and economy to another crisis. Some analysts are already worried about high prices for real estate, stocks and other assets.
In addition, persistently negative rates could force European banks to raise fees on checking and savings accounts to recoup the rising cost of depositing reserves at the central bank. This, in turn, would encourage individuals and businesses to take some of their money out of banks and stash it in safes, or even under mattresses. And that would not be good for the stability of European banks.
Mario Draghi, the president of the E.C.B., clearly understands the risks of negative interests rates, which is probably why he did not lower rates further last month. But there is only so much he can do. The political leaders of Europe need to help him revive Europe’s economy.