As the ripple effect of the COVID-19 pandemic rages on, central banks have been quick to act in slashing interest rates. However, with rates already sitting at historic lows before the crisis, it is possible that central banks may be forced to employ more unconventional and controversial techniques to try and calm the economy as time goes on.
The most meaningful rate cuts happened on March 3 and March 15 after emergency meetings in the United States.
On March 3, the Federal Open Market Committee cut the target rate from 1.5% to 1.0% and then, on March 15, the rate got chopped by an entire percentage point to rub up against the lower bound of zero.
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As you can see on the chart, this puts us back into familiar territory: a policy environment analogous to that seen during the recovery from the financial crisis.
With interest rates again bumping up against the lower bound, you’ll begin to see discussions pop up again about the effectiveness of zero interest rate policy (ZIRP) and even negative interest rate policy (NIRP)
Here’s a quick primer on both:
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With rates sitting at zero, it’s not impossible for the Fed and other central banks to begin toying more seriously with the idea of negative rates. Such a move would be bold but also seen as highly experimental and risky with unforeseen consequences.
Since only the beginning of March, the world’s central banks have cut interest rates on 37 separate occasions except for the National Bank of Kazakhstan, which raised its key rate by 2.75% to support its currency in light of current oil prices.
Going into the year, rates in developed economies were already between 0% and 2% and below is a look at cumulative interest rate cuts by some of the world’s most important central banks, from Jan. 1, 2020, until today:
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Despite not having much room to work with, banks have slashed rates where they can — and now out of major developed economies, Canada has the “highest” interest rate at just 0.75%.
Helicopters on the Horizon
With central banks running out of ammo for the use of traditional measures, the conversation is quickly shifting to unconventional measures such as “helicopter money” and NIRP…
[The additional information below is from Norman Mogil:- Helicopter money is an unconventional monetary response in which individuals receive direct payments from the government to use at their own discretion.
- It is usually considered as an alternative to the more familiar quantitative easing (QE) which is being deployed by the Federal Reserve, the ECB and the Bank of Japan
- QE and now helicopter money are in response to an economy that is in a “Keynesian liquidity trap”.
- A liquidity trap occurs when, despite interest rates being zero or even negative, individuals and business do not increase their borrowings and the economy remains in recession.
- In principle, helicopter money seems quite simple yet, politically, the issues resolve around whether to provide direct cash benefits for everyone or for those in need. If it is latter, then how does the government determine who in need?
The original article by Jeff Desjardins has been edited for the sake of clarity and brevity to ensure a fast and easy. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.