In Janet Yellen’s Q&A with the House Financial Services Committee, Rep. Tom Emmer asked about the possibility and consequences of negative interest rates.
Emmer (R-MN): “Will the Federal Open Market Committee ever rule out going to negative interest rates?”
Yellen: “’Rule out’ is something we tend not to do. [...] If circumstances were to change, suppose economic outlook--which I don’t expect--but if it were to deteriorate in a significant way, so that we thought we needed to provide more support to the economy, then, potentially anything including negative interest rates would be on the table.”
While the “hawkish” October FOMC statement specifically points to their next meeting as a viable date for raising rates by 25 basis points (since when did idle threats to raise rates by 0.25 become “hawkish”?), Yellen won’t rule out the possibility of barging through the zero “lower bound” if conditions worsen. In such a scenario, the Fed would charge negative rates on reserves held by banks, meaning that banks would have to pay the Fed for keeping excess reserves. Only this rate and the Fed Funds rate would actually go negative, but other interest rates would certainly be pushed downward like in other expansionary policies.
The Fed causes distortions in the way capital is used in production when they push interest rates below what the market interest rate would have been. Artificially low rates create bubbles by making investments look more profitable than they will turn out to be. Negative interest rates are not only artificially low, but entirely impossible in unhampered loan markets--although many would love to borrow, nobody would pay for somebody to borrow from them. As such, the distortions, malinvestments, overconsumption, bubbles, and economic havoc would be all the more intense with artificially negative rates.
