Waking up from monetary illusion

Should negative nominal rates on savings accounts be welcomed?


The ECB’s historic moves in June and September 2014 to impose negative nominal interest rates on bank deposits in order to prevent banks from hoarding cash with the ECB raised several important questions: What if banks in turn follow the same idea and impose negative nominal rates on savings accounts? In our opinion, this partially justified fear misses the point and is the perfect example of what economists name “monetary illusion”.

Pros and cons of negative nominal saving rates

There are good reasons why nominal saving rates should go negative in order to prop up the economy. First of all, too much cash is currently stashed in European retail deposit and savings accounts. In a period of stagnation and weak economic growth, this represents a huge opportunity cost as all this money could be invested elsewhere, in bonds or equities for instance or to finance new investments and new businesses. In addition, the current bottom-low return proposed by savings accounts does not seem to deter economic agents from stashing substantial amounts of their money away from where it would be most needed. More dynamic measures could therefore change the current situation and lead to a better allocation of resources.

Nonetheless, implementing a negative nominal rate on savings accounts could have many adverse effects, including people pulling all their cash out of their bank to keep their savings at home in a safe or, in the worst scenario, potential bank runs. Such reactions though do not seem to be likely to happen on a large scale, partly because people still value the service provided by banks to keep their money in their bank accounts. In this sense, people would therefore be ready to pay for that service. According to these views, the benefits of negative saving rates seem thus to outweigh the costs.

Not politically feasible

One should not forget that politicians make laws, not economists. Therefore, even though negative interest rates would be welcomed according to some of the preceding arguments, such a move is hard if not impossible to make if we take into consideration the political dimension of this issue.

Quite recently, Koen Geens (CD&V), the Belgian minister of Finance expressed the idea of widening up the existing fiscal advantages on savings accounts as a way to boost the economy. Even though this proposition sounds less harsh than negative interest rates, the final effect would be exactly the same: savers end up with less return regarding their bank accounts. So far Mr Geens’ proposition has not received the backing of many political parties even though a wide range of economists in Belgium have been advocating an end to the current tax subsidy granted to savings accounts. To quote Mr Eric De Keuleneer, CEO of Credibe, talking to the Solvay Student Review. “the tax advantage on savings accounts has changed from being an enticement for savers to being a subsidy for banks, and a bias that discourages savers from useful financial instruments”. However, despite these recommendations, it seems much likely that Mr Geens will have to fight hard if he wants his quite unpopular project to be more than a draft law.

It is also worth remembering what happened in Cyprus one year ago: banks were in trouble and on the verge of default, the government stepped in and decided to levy a ”tax” on all domestic bank accounts to refinance its banking sector, with savers being compensated with shares that were likely to fall in value in the near future. This led to unprecedented popular demonstrations in the streets and to public disapproval worldwide.

Stimulating inflation to boost…financial repression

As long as inflation is at bay and nominal saving interest rates are near zero but not negative, real interest rates are negative and there is an implicit tax on savings accounts. In addition, this so-called tax does not produce any fierce reaction from economic agents thanks to monetary illusion and the situation benefits directly banks and national governments as the latter do not have to take some unpopular measures to refinance the banking sector, such as levying more taxes. However, if inflation peters out (as has been the case since 2010 where growth in CPI accounted for 3.49% compared to about only 0.03% in August 2014 so far), and nominal interest rates on savings accounts are already near zero, real interest rates surge making both banks and governments worse off.

In this context, we could ask ourselves the following question: Is the ECB’s concern about bolstering inflation and preventing deflation strictly motivated by purely economic reasons such as boosting employment and entrepreneurship or are there other hidden reasons behind that seem to be much less acceptable, such as supporting the implicit tax on savers? The answer to that question remains open to debate.

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