It is instructive to remember that only a few years ago it was common for negative interest rates to be dismissed as impossible.
Self-proclaimed experts would declare that zero was the lower bound below which rates could not fall.
Reality has skewered this view over the past two years. Since mid-2014 four European central banks have turned their policy rates negative: those of Denmark, Sweden and Switzerland as well as the European Central Bank (ECB). In addition, the Bank of Japan adopted a policy of negative interest rates in January. That means a large part of the developed world is living under a negative interest rate regime.
Of course the wiser pundits always added the caveat that real interest rates cannot go below zero. So far, at least they have only gone negative in nominal terms.
That may be true but it is still striking that rates are exceptionally low across the advanced economies. In the US and the UK they are technically positive but low by historical standards.
What is more, it looks like this situation will remain for a protracted period. An ECB statement on its recent reduction in interest rates linked to an article arguing that negative rates “should become a regular part of the central bank toolkit”.
I argued previously in IPE that ultra-loose interest rates only create an unhealthy dependence on cheap credit (‘End the monetary addition’, December 2015). They are a way of pushing back a much needed restructuring of the real economy. Rather than creating the basis for a new round of capital investment, they allow both business leaders and policymakers to prevaricate.
In that sense they are far from the bold policy that some have claimed. On the contrary, they are an exercise in institutional timidity. They mean evading difficult economic decisions rather than acting resolutely.
There are two key reasons why such a misguided policy has gone on for so long. First, the West’s economic plight is seen too narrowly as one of insufficient demand. It is rarely understood that the developed economies have suffered a protracted productive weakness since the 1970s.
Second, politicians have outsourced key parts of economic decision-making to central bankers. In Europe most of the main decisions on interest rates were made by politicians until the 1990s. The notable exception was the Bundesbank, which was independent from its inception.
The problem with this set-up is that it is isolated from democratic control. There is no popular pressure on unelected technocrats to take the decisive action needed.
As a result, Europe’s inhabitants are facing a long and painful squeeze in their living standards. Cuts to pension payouts in several developed economies are only one manifestation of this negative trend.