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IMF Chief Lagarde Just Endorsed This Radical Policy Once Thought Impossible

IMF chief Christine Lagarde endorsed use of negative interest rates, a radical idea most thought was impossible.

By David Francis

March 18, 2016, 12:17 PM

This week, U.S. Federal Reserve Chair Janet Yellen said she was concerned about slow growth in Japan and the European Union spilling into the American economy. Both allies are taking a big -- if controversial -- step to counter the stagnation, and it just got a big endorsement.

This week, U.S. Federal Reserve Chair Janet Yellen said she was concerned about slow growth in Japan and the European Union spilling into the American economy. Both allies are taking a big — if controversial — step to counter the stagnation, and it just got a big endorsement.

Christine Lagarde, managing director of the International Monetary Fund, said Friday in an interview with Bloomberg that Japan and Europe would be in bad shape if not for negative interest rates. It’s a policy embraced by both the European Central Bank and the Bank of Japan, and it requires bond purchasers to pay for the privilege of storing money in national reserve banks, as opposed to earning interest on it. In other words, depositors are charged to save cash.

Normally, bond issuers — whether a corporation or a government — agree to pay interest to buyers. Negative rates flip the script. Investors who buy bonds with below-zero rates agree to pay the bank to hold their money. It’s an incentive for investors to aggressively spend on stocks, businesses, and other money-making assets to mitigate the financial loss of buying bonds — and, theoretically, stimulate the economy.

“If we had not had those negative rates, we would be in a much worse place today, with inflation probably lower than where it is, with growth probably lower than where we have it,” Lagarde said. “It was a good thing to actually implement those negative rates under the current circumstances.”

The use of negative rates was once thought to be impossible because of the fear that people would withdraw their cash from banks rather than pay to store it. So far, this has yet to occur.

But negative rates also are a sign of desperation by monetary policymakers in Europe and Japan. It’s a measure of last resort, because other available tools, like quantitative easing (when a central bank floods the market with money) or interest rates of zero (which makes it free to borrow) have worked.

Unlike Japan and Europe, U.S. economic growth has been consistent in recent years; in 2015, GDP grew by 2.7 percent, and it’s expected to expand by 2.8 percent this year, according to the World Bank. But memories of the Great Recession are fresh, and Yellen has not ruled out joining her Japanese and European counterparts in embracing negative rates.

When she announced this week that the Fed would keep U.S. interest rates at .25 percent, Yellen said the U.S. central bank was not considering negative rates at this time. But she added this caveat: “There are tools we could turn to in the unlikely event that we need to add accommodation.”

Photo credit: Getty Images