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The presence of cash limits the ability of central banks to make interest rates negative. Gertjan Vlieghe, economist at the Bank of England, said this earlier this week in a speech. He explains that the policy room of central banks is much smaller than before the credit crisis of 2008, because interest rates are already very low. With negative interest rates, central banks have less room for manoeuvre, because the effectiveness of monetary policy will diminish as long as cash remains available as an alternative.
Normally, it's not attractive to hold cash because it doesn't yield any returns. In a world with negative interest rates, this works the other way around, because then it is attractive to hold cash. For this reason, Vlieghe argues for a rapid transition to digital central bank money. This will give central banks more opportunities to pass on negative interest rates. Also to small savers.
"The main constraint that simultaneously limits how low the policy rate can go and how effective it is at low levels is that cash is available as an alternative and that one does not pay interest on it. This interest-free aspect of cash is described under normal circumstances - when the interest rate is positive - as the cost of holding cash. But when interest rates turn negative, the zero interest rate on cash is in favor of holding cash. It is basically a subsidy on cash relative to other assets.
The more negative the interest rates, the more attractive cash is. At some point, this could lead to an exodus of the banking system, either of profits or deposits, or of both. This could have an adverse effect on the economy if interest rates are sufficiently low."
The Bank of England, like many other central banks, is struggling with cash. People are using it less and less in daily payments, but with negative interest rates it can fulfil the role of a means of saving. This limits the room for central banks to raise negative interest rates. In doing so, they risk that people will withdraw their money from the bank en masse. That is why central banks around the world are working on digital central bank money, with which it is no longer possible to escape negative interest rates.
"Neither the cost (when the interest rate is positive) nor the subsidy (when the interest rate is negative) of cash are intrinsically desirable properties. Rather, they represent a technological limitation, namely that it is rather impractical to pay or charge interest on cash. As central banks, including the Bank of England, consider switching to central bank digital money (CBDC), this restriction may be easier to circumvent in the future.
If digitalisation becomes sufficiently widespread that there is much less use of cash, this opens up the possibility of having more negative interest rates in the distant future, without negatively affecting banks' profits. Interest rates on all safe assets would then become negative, allowing banks to maintain their net interest margin. Bank deposits are then no less attractive than other assets with negative interest rates."
Central banks struggle with negative interest rates because it undermines the stability of the financial system. Savers are seeing the purchasing power of their money evaporate, while the revenue model of banks is under pressure. Adjusted for inflation, interest rates are currently at an all-time low. This means that the threshold for savers to withdraw money from the bank is getting lower and lower. At the moment, people can still withdraw cash, but central banks can close this escape route.
With central bank digital money, central banks will be able to withdraw cash from circulation over time. As a result, this possibility of avoiding negative interest rates is no longer available. In addition, with central bank digital money, central banks More control about our money. Fortunately, there are still alternatives, because precious metals such as gold and silver are also not affected by negative interest rates. These precious metals will benefit from an environment of negative interest rates and increased financial repression.
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This contribution was made from Geotrendlines
