Interest Rates go Negative: Compare Riksbank (Sweden) with our Federal Reserve

Author: David Kotok, Post Date: July 9, 2009

Negative nominal interest rates are very hard to understand intuitively.  That said, we now have a central bank using them.

In its July 2, 2009 press release, Sweden’s central bank explained that it cut its policymaking “repo rate” to 0.25%.  Its penalty lending rate was cut to 0.75%.  Most observers expected it to cut its reserve deposit rate to zero.  The observers saw zero as the realistic lower bound of interest rates.  They were wrong.

Sweden’s reserve deposit rate was set a -0.25%.  That’s right.  A negative interest rate is now at work in one of the G-10 countries.  This rate means a penalty is charged against a deposit placed in the central bank under the reserve deposit rules.  The banking institution that deposits with its central bank will receive an actual deduction from the deposit account.  It will get back less money than it puts in.

Negative nominal interest rates are designed to discourage an activity.  They are rare.   The most dramatic one that I remember in my professional career was instituted by Switzerland several decades ago.  At that time there was a flight from the US dollar into other hard currencies around the world.   The US was leaving the Bretton Woods fixed exchange rate regime which had prevailed since the end of World War II.  Massive inflows into the Swiss franc were resulting in a build up of interest bearing deposits in Swiss banks.

The Swiss banking system could not process the deposit inflows from around the world in a way that enabled them to maintain traditional banking spreads and functionality.  These flows were motivated by global money transfers out of the US dollar.  After lowering rates did not stem the incoming flows the Swiss authorities finally imposed a 5% negative interest rate on non-Swiss citizens.  That‘s right.  You put a hundred francs in a savings account and at the end of the year you got back 95 francs.  That is how a negative interest rate works. 

The Swiss accomplished their purpose.  Massive inflows from US dollars into Swiss francs came to a screeching halt and promptly reversed.  Human behavior changed.

The Swedish central bank is trying to use negative interest rates to alter risk taking behavior in Sweden.  It wants its member banks to use excess reserves to acquire risk assets rather than just place them with the central bank.  Hence it has moved its reserve deposit rate to a negative number.  It did this because it has lowered its other policy rate to near zero and it decided to maintain its band around them. 

Time will tell if this policy works.  It will be observed closely by the other G-10 central banks including our Federal Reserve.  They should observe with good reason.  

Policy interest rates in most parts of the world are now near zero.  Gradually the world’s central banks are committing themselves to a longer period of these very low rates.  In Sweden the term repo loan to its member banks is now out to 1 year.   The European Central Bank recently did a large infusion of reserves with a 1 year facility.  The US Federal Reserve has not followed this pattern and favors the shorter term.  Shorter terms mean more uncertainty.  More uncertainty means higher risk premiums.  Higher risk premiums mean more market volatility and tepid economic recovery.

In the US, our Federal Reserve seems to be behind the eight ball.  It still uses shorter facilities and it still tries to communicate without press conferences after every meeting and with the arcane language of “fed speak.”   The financial crisis notwithstanding, our Fed has not achieved transparency and still functions with a foggy cloud of opacity.

Our Fed is also threatened politically and fears an attack on its central bank independence.  It has been held political hostage at the Board of Governors level by Senator Christopher Dodd and the Senate Banking Committee.  Dodd kept two of the seven governor seats vacant by refusing to hold a confirmation hearing for the Bush presidential appointees.  He is personally responsible for the failure of the United States to operate with a full Board of Governors during the recent financial crisis.  We will never know how many actions didn’t happen because of Dodd’s obstinacy.  We will never know how many homes were foreclosed in the United States because the Chairman of the US Senate Banking Committee played politics with our central bank.

So far President Obama has continued this political structure.  Obama promised “change.”  In monetary affairs we’ve gotten worsening actions, and tax scofflaw appointments. And, due to politics, we still only have five of the seven governor positions filled.  The Fed still has to achieve unanimity to make an emergency decision.  The law is designed for the Fed to operate under a super majority rule and NOT a unanimity rule.  The law is not designed to give every sitting Fed governor a veto over any emergency decision.  Yet that is how it has operated for three years.  Thank you, Senator Dodd and now, thank you, President Obama.

This appalling behavior is still ignored by most market observers and most media.  That is the citizen’s loss and the journalist’s failure.  We hope the price paid for this political interference with central bank independence doesn’t become a repeat of the US dollar crisis we saw in the 1970s when President Nixon revoked dollar/gold convertibility and the US left the Bretton Woods regime. 

There will be some discussion about central bank independence today at 1:15 on CNBC Power Lunch.  I do not know who else will be in the conversation and how long a time span it will cover.  But this writer has been asked to be one of those interviewed.  And, I have been advised that there is an opposing point of view.  The issue to be discussed is the role of the Fed as a regulator.  For me that means the role of the central bank in an even more intense political role and that means with even less independence. 

Readers may want to read the monetary policy report of the Swedish central bank to see what a clear and understandable monetary policy explanation can look like.  Check out and the July 2 release and the full report.   Imagine if our Federal Reserve presented the monetary policy outlook for the United States and the view of the rest of the world with such descriptive clarity of the policy options being considered.  Maybe if they did that, maybe if they realize how deeply damaged the Fed is and how the political forces in the US are threatening central bank intendance, maybe if the country realized how important this issue is for the value of the currency, maybe, just maybe, we might get enough attention to reverse this slide that is taking our country into a monetary abyss. 

If there is no warehouse fire or other breaking news, we may just have some serious discussion about central bank independence and what a central bank is supposed to do to maintain and preserve the store of value characteristic of the nations’ money, provide a medium of exchange and set the standard for a unit of account.   That is the job of the central bank.  Its second task is to explain that job to the citizens.

To see how to do both in the midst of a financial crisis we may want to look to Sweden.  They are trying and have learned the hard way with the Scandinavian banking and financial crisis two decades ago.  And they have managed to report their methods and actions in English as well as Swedish. 


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