Even Withdrawing Your Money From the Bank Won’t Save You From Negative Rates

I used to say that when short-term interest rates hit zero, and yet the major economies were still stuck in a rut, that this should surely demonstrate the impotence of Keynesian policy prescriptions. Alas, I was too naive. Now the discussion of “negative interest rates” is all the rage.

Traditionally, economists would have thought negative (nominal) interest rates were impossible, because if the Fed (say) started charging banks for keeping their reserves parked at the Fed, then the banks would simply withdraw their reserves from the Fed in the form of currency. And, if commercial banks ever tried to impose negative interest rates on checking account balances, then obviously their customers would respond by withdrawing their funds and holding them in the form of paper currency.

Yet don’t worry! Top economists are coming up with ways to neutralize this strategy. A recent FT article explains (it’s paywalled so I’m quoting from this Scott Sumner post):

“First, it is not as if depositors as a class actually have a legal right to convert all their money to cash as it is. You cannot present a debit card at the Bank of England and demand cash. Indeed, even your own bank limits how much cash you can withdraw, as Frances Coppola has pointed out. Just read the fine print of your account terms of service.

And how could private banks honour mass withdrawals of cash even if they wanted to? No law provides for the central bank to swap client deposits for cash; only central bank reserves. And despite the huge growth of reserves in recent years, these still amount to only a fraction (about one-fifth in the UK) of bank deposits. So, to honour customers’ demands, banks would have to borrow more reserves from the central bank, which could impose terms as onerous as it wished. Onerous enough that banks would try to pass the cost on to customers. As my colleague Richard Milne argues in an analysis of Danske Bank’s success — its market value now exceeds that of Deutsche Bank — Danske is thriving because it has adapted to Denmark’s negative rates, in part by indeed passing them on to customers.

Second, the BoJ’s and SNB’s set-ups to neutralise banks’ incentive to hold cash instead of reserves can be exactly duplicated by the banks themselves vis-à-vis their customers. You want to take cash out of your account? Be our guest, but we will keep track of your total balance of net cash withdrawn and charge you the same interest on that balance as we charge on your deposits. This can be implemented through one of the regular “updated terms and conditions” that our banks seem to impose on us unilaterally every so often.”

So for example, let’s say you originally had $5,000 in your checking account. Then your bank imposes a -1% interest rate. If you leave your whole $5,000 in the account, then over the course of the year the bank would charge you $50. (I’m ignoring compounding for the sake of simplicity.) So at the end of the year you’d only have $4,950 in the account.

Now suppose in reaction to your bank’s move to impose negative rates, you pull out $4,000 in cash. You literally hold green pieces of paper in the wall safe in your house. You keep $1,000 on deposit with your bank, because after all you need to pay bills and so forth and you don’t want to give up the advantages of commercial banking altogether.

Normally, you’d think that you just cut your losses by 80%. You would think that the remaining $1,000 in the account would incur a bank interest amount of (-1%)x($1,000) = -$10. So that your $1,000 would turn into $990.

However, as the quotation above indicates, economists are toying with ways to take that option away from you. What if your bank kept track of your long-term history, and so when you pulled out $4,000 in cash, your bank charged an interest rate of -5% on your balance? Then they’d charge you (-5%)x($1,000) = -$50.

This is yet another reason to seriously consider Nelson Nash’s ideas for Becoming Your Own Banker.