A strange invention called negative interest   

In July 2022, the ECB ended its policy of negative interest rates. Since 2014, it had imposed such interest on the banks. These, for their part, felt justified in imposing negative interest on their customers, distortingly paraphrased as a 'custody fee', or even 'penalty interest'. No doubt that customers perceived that invention as an unjustified penalty. As long as interest rates do not return to an extremely low level, the issue of negative interest rates is off the table. Nevertheless, it remains a significant example of how unreasonable counter-productive measures can be taken on the basis of apparent rational arguments. From this angle, the following paper remains relevant.

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Negative Interest – hoping in vain for a miracle tool  
The zero lower bound and the concept of negative interest

In 2008, the short-term central-bank interest rate in America and Europe was reduced to 0% or close to this lower bound. Long-term sovereign bond rates also fell to such very low rates and were later offered partly with negative yields. This was the end of a long-term decline in interest rates that started in 1980 at about 15%. As interest rates cannot naturally slip below the zero lower bound there was then no more room for conventional base-rate policy. That situation was new. Never before had interest rates fallen so far. Even at the lowest point until then, in the years after the Second World War, the US Federal Reserve rates remained above 2%.

At the zero lower bound, central banks cannot continue with what they are used to, that is, lowering the base rate when general levels of interest and prices disinflate or even deflate, and raising the base rate when general levels of interest and prices reflate. In the advanced stage of an upswing this is supposed to dampen money and credit creation, economic overheating and undesired high levels of consumer price inflation (CPI), while lowering the rates is supposed to facilitate additional money and credit creation, supporting a turn-around to economic recovery and a desired CPI rate, which is nowadays set at 2–3%.

Following the prevailing logic, the zero lower bound is seen as a nuisance, even as 'mone­tary paralysis'.[1] The zero lower bound is not accepted as the natural limit that it is but is considered to be a hindrance that needs to be overcome, and some eco­no­mists have a ready sugges­tion: breaking through the lower bound by impo­sing nega­tive inte­rest.[2] This means making a creditor pay interest to the debtor, rather than the debtor paying interest to the creditor. In the case of bank account balances – bankmoney for short – this is inter­preted in such a way that a levy is payable on a positive account balance, rather than the bank paying deposit interest to the account holder.

The question as to whether such negative interest is really interest, and if not, what it is – administrated loss of purchasing power, a bank custody fee, passing on costs, or possibly a property offence as a quasi-money tax or a special levy to compensate for shrinking interest margins – these ques­tions will be addressed in later sections of this paper.

Whatever it is about, proponents of the measure hope it will restore the effectiveness of conventional interest-rate policy. The deduction of account balances would encou­rage money holders to spend the money rather than watch it drain off. This, in turn, would trigger demand-induced growth, counteracting dis­in­fla­tio­nary or even defla­tio­nary ten­den­cies, thus leading back to the normal state of positive interest rates. As explai­ned in the fol­lo­wing, such expec­ta­tions are not fulfilled. Instead, the arbitrary con­struct of negative interest is proving to be counter-productive.

Charging negative interest

In mid-2021, the negative rate the ECB charges the banks, and ever more banks charge their customers, was 0.5% p.a., broken down to an account's daily over­night posi­tion. The negative rate is charged on current account balances and also on time and savings deposits, depen­ding on the bank. Initially, only business customers with account balances of more than 100, 250 or 500 thousand euros were affected, but now more and more banks are also charging private balances of any amount. In July 2021, 372 banks were imposing negative interest in Germany alone, more than twice as many as in the previous year.[3] More banks are announcing they will follow suit.

The Swedish Riksbank was the first to introduce a negative overnight rate of -0.25% on bank reserves in 2009. The ECB raised negative interest rates on its deposit facility for banks (excess reserves) stepwise from 0% in July 2012 to -0.5% today. The central banks of Denmark, Switzerland and Japan did likewise. A special reason for the Swiss was to counteract the revaluation of the franc. The Danes wanted to defend the krona's peg to the euro.[4] The US Federal Reserve and the Bank of England, by con­trast, have wisely decided to dispense with negative interest.

Cash – the inconvenient remainder

An obvious snag with the negative interest proposal is still-existing cash. Apply­ing nega­tive interest to coins is next to impossible, and applying it to notes would be quite cumbersome. According to Gesell (1916), to whom the idea of an admi­nis­trated loss of purchasing power dates back, banknotes would periodically be deva­lued by 6% p.a. Making up for the loss would require people to buy stamps of the same amount to be put on the notes. Otherwise, the notes would no longer be valid; hence the term stamp scrip.[5] Then as much as today, this would hardly appear to be practical.

Therefore, negative interest is applied to deposits only, while cash is exempt. However, should negative interest be implemented at a significant rate, many people are likely to sidestep the loss by switching to cash. Under today's conditions, where cash only accounts for about 5% of the euro area's active money supply, this would result in a severe shortfall of cash and trigger bank runs – an in-built emergency in present-day fractional reserve banking which policy makers will not wilfully want to provoke.

Not surprisingly, policy makers pressing for the adoption of negative interest are also pressing for the abolition of cash. Large banknotes are being withdrawn from circu­la­tion. The public now only pays petty sums in cash, everything else non-cash. Even for smaller sums, many firms and all public bodies demand cashless payment. The dis­appea­­rance of cash is fore­see­able, even if it is a long time coming.

Bankmoney now accounts for up to 90–95% of the public money supply (M1), while the share of cash has corres­­pondingly fallen to 10–5% and even less. Most of the cash, moreover, is not in active circulation but held as a safety buffer or, in the case of the US dollar and the euro, used as a parallel currency abroad.[6] In this situation, banks too would prefer to see cash disappear. Financing and handling solid cash are more expensive for banks than the fractional financing and electronic handling of bank­money. The prospect of a bank run for cash alone motivates the banking industry to push ahead with driving out cash – which in turn weakens the remaining central-bank control over today's mega­banks all the more. So not only advocates of negative interest but also banks in general no longer want to leave the disappearance of cash to the payment habits of money users.[7]

In response to these and other developments, both sovereign-money reformers and central banks have developed plans to introduce central-bank digital currency into public use (CBDC) – be it in the form of central-bank account balances or crypto tokens – as a replacement for the dwindling cash base. Among the pioneer approaches were the CBDC concepts of the Bank of England and the Swedish Riks­bank.[8] At the same time, these otherwise welcome plans for digital currency – that is, sovereign money – fit nicely together with negative inte­rest.[9] An IMF study on the subject expressly states that CBDC 'would eliminate the effective lower bound on interest rate policy'.[10]

Instead of the outright abolition of cash, another approach is to 'decouple' cash from bankmoney and reserves, imagining cash as a sort of 'parallel currency'.[11] Putting it this way is quite misleading, because this approach, rather than 'de-coupling' cash, aims to achieve the 're-coupling' of cash under conditions of negative interest. The idea is not to discontinue the 1:1 parity between cash and reserves/deposit but – in parallel with negative interest – to levy a special 'conversion rate of cash' (CRC) equal to the nega­ti­ve interest rate. The rate would be charged, when cash is withdrawn from an account, that is, when bank deposits are converted into cash. Such a CRC is assumed to cancel out the exemption of cash from negative interest.

Why negative interest does not achieve what it is supposed to  

Central banks have ways to help a faltering economy get on its feet, not only banks and non-GDP finances, but also GDP finances and the real economy. For example, massive central-bank purchases of government bonds, while creating a mone­­tary overhang problem in the banking and financial sectors, have been effective in stabilising government spending and overall economic activity. Another example is the ECB's TLTRO programme (Targeted Longer-Term Refinancing Opera­tions). It serves the direct promotion of capital expenditure in the real economy and so far amoun­ts to a total volume of almost 1.5 trillion euros, and this at rock-bottom interest rates. That undoubtedly helps.

As far as negative interest rates are concerned, however, it remains unclear, both with regard to the banks and the financial economy as well as the real economy, why nega­tive interest rates would be an answer to the problems of sub­­opti­­mal real-economic capa­city utili­sation and an over­all tendency that has so far been dis­in­fla­tio­nary rather than reflationary. Even if the transmission lever of interest-rate policy were much stron­ger and banks were able to impose much higher negative interest on their cus­to­mers, why would such a noticeable loss of purchasing power incentivise firms to take up more credit for capital expenditure and consumers to spend more?

Early research evidence
Early studies on the implementation of negative interest have reported what was to be expected: negative interest did not bring about noteworthy positive or negative effects. Two reasons were given. Firstly, negative interest was initially imposed by central banks on banks, much less by banks on customers; secondly, the rates applied were considered too low to have made a difference. Applying higher rates was out of the question for fear of a bank run, and there was also some reluctance from the side of central banks to burden the banks' balance sheets.[12] The banks from their side expressed concerns that competition would make it difficult to pass on negative interest to customers.[13] In the meantime, the cooperative banking principle seems to prevail, suggesting that something is feasible – be it creating credit, or bank­money, respectively, or imposing negative interest – if all banks do so likewise.

Overall there was no effect, except that the central banks made profits at the expense of the banks – while ever more banks, the broader the basis on which they charge negative interest, are taking from their customers more money than the central bank is charging the banks. More on this later.

Evasive behaviour I – Switching the bank and transferring accounts
With negative interest rates around -0.5% not yet imposed across the board and also graduated according to account balance, the levy has not yet caused too much upheaval. Nevertheless, negative interest has by now become a press issue due to the unrest that has arisen from affected customers shifting their bank balances, or at least the greater part of them, to banks that do not yet charge negative interest. Switching the bank and transferring account balances involves some effort and expense. The publicised anger about negative interest as well as related lawsuits by consumer protection agencies have also increased.

At the same time, there are now banks turning away new cus­to­mers, in particular nega­­tive-interest fugitives. Not being welcome at banks with your money sounds like the world is upside down – which in fact it is. New customers and related incoming pay­ments provide the banks with reserves in the same amount. Under normal con­di­tions, the reserves were welcome as means of financing for the banks. In the meantime, however, due to the massive open market purchases of secu­ri­ties by the central banks (Quan­ti­tative Easing), which they pay for with reserves, the banks have been literally flooded with excess reserves; a flood which they cannot use sensibly in this amount, but on which they have to pay negative interest to the ECB and also hold minimum reserves as required. To the extent the flood of reserves that was flowing into the banks cannot be invested profi­tably, while negative interest rates are levied on the reserves, this only creates costs for the banks, but no earnings.

Evasive behaviour II – Financial investment
Banks advise their customers to circumvent the negative interest rate by making investments (whereby the bank in question earns commissions). This means, for example, buying real estate as a finan­cial invest­ment, or shares, ETFs, money market funds, or investment funds of various kinds. At first sight, this is plausible and also applies to the banks themselves vis-à-vis the central bank. But such additional formation of finan­cial capital is not unproblematic, and may even be unde­si­rable from a macro­­eco­­nomic and social point of view.

In case of need, investments may not be liquidated quickly or only at unfavourable prices. The extra demand for securities, whose trading does not generally contribute to financing the real economy, promotes asset inflation and the formation of bubbles, and thus instability and proneness to crisis. Over time this also leads to an increase in financial income to the relative detriment of earned income and thus to increased inequality of income and wealth.

In the overall picture the escape from negative interest is an illusion. The customers' bankmoney and the banks' excess reserves do not disappear when they are used to buy something. The money merely changes its owners, thus always being with some owner. This is perhaps more true for business customers than for private ones, and it is especially true for the banks’ high-powered base of reserves. The bankmoney regime based on fractional reserves rests on the fact that outgoing and incoming payments among the banks roughly offset each other and that payment deficits that never­the­less occur can be settled by money market credit, intra-day or overnight. In other words, the reserves that banks spend come back to their central-bank account quite quickly in various ways. The bigger the bank, the more this is true.

The mostly futile attempt of the banks to reduce their stock of reserves through finan­cial investments had already become clear in the early studies on the subject cited above. The reserves would only disappear temporarily if the central bank sold the secu­ri­ties it holds to the banks. When the securities mature, however, the equivalent value in reserves would flow back to the banks again.

Evasive behaviour III - Spending money faster (without spending more)
Another attempt to circumvent negative interest rates is to spend money more quickly, similar to the year-end spending panic in public households that are not allo­wed to carry over balances into the next year. By itself, this does not result in more money being spent, so it does not boost growth, prices and interest rates. Expectations of faster spending resulting in money being spent more often remain vague. The velo­city of money circulation, or use frequency, respectively, is rather stable and only changes in the long-term course of technical innovations, economic structural change and changes in social behaviour.

Compensatory behaviour - Spend less, save more
Rather than spurring faster or additional expenditure, negative interest is also likely to trigger the opposite, that is, com­pen­sa­tory spending cuts (except under conditions of runaway in­fla­tion). The additional savings lie idle as deactivated bankmoney in savings and time accounts, or are invested in non-GDP finance. Both are detrimental to the real economy.    

During the 1950–70s, when CPI was high and temporarily even in the double-digit range, did people hurry up to spend their income? No. Instead, they demanded higher wages and extended social security and benefits. It was the times of the spiral of rising prices and wages. For firms and households alike, experiencing less purchasing power either means to strive for higher earnings, or to save on expenses.  

The misinterpreted Wörgl experiment – negative interest's alleged proof of concept

Some supporters of negative interest expressly refer to Gesell's 1916 concept of demur­rage on holding cash and the 'Wörgl miracle' of 1932.[14] Gesell quite frankly called his approach 'Schwundgeld', literally meaning 'shrinking money'. He thought in terms of a cash economy, the cash certainly as freely created fiat money ('Freigeld') but cash nonetheless. The credit theory of money from the 1890s and the perception of the ascendant bank­money regime had not yet reached him. He almost equated having money with hoarding it. The matter inspired Keynes's notions of liquidity pre­fe­rence and the liquidity trap. To dis­cou­rage 'hoarding' and stimulate spending for money to 'make the world go round', Gesell considered a demurrage rate of 6% p.a. to be appropriate. He wanted to exclude savings deposits from this for he saw savings as a loanable cash fund (rather than the stock of deactivated bankmoney it was increa­singly becoming).

One might give credit to Gesell even in his time that hoarding money was a serious problem in the earlier days of gold- and silver-based cash economies. Under present-day conditions of fiat money, which can in principle be created in any amount, 'hoar­ding' is not a serious problem anymore. Keynes's problems of liquidity preference and the liquidity trap need be seen in perspective accordingly. Most people never happen to sit in a liquidity trap but are happy when they manage to make ends meet. The well-off, for their part, do not sit on money but on capital, most often financial wealth and property. If those who decide over capital expenditure want to invest, they take up credit, the bankmoney for which the banks and shadow banks are happy to provide.     

The best known test of the idea is thought to have taken place in 1932 during the Great Depression in Wörgl, a small town in Tyrol. After two factories in the town were shut down and unemployment had reached 30%, the mayor resorted to issuing municipal emergency notes of an overall amount of 5,000 schillings, at par with the official currency. Local emergency money was issued at the time in dozens of other places in Austria and Germany. The Wörgl notes, however, were subject to demurrage of 12% p.a., 1% at the end of each month.

The money was spent into circulation in payment of public works commissioned by the town administration. Initially, small businesses such as pubs, shops and craftspeople were reluctant to accept the money, but were eventually won over. The mayor's initiative was crowned by success. The local economy recovered to a degree, which was perceived as a little economic miracle.[15] After just one year, however, the Wörgl notes were suppressed, like all other local emergency currencies, at the instigation of the Austrian National Bank. This unnecessarily aggravated the economic situation, parti­cularly in combination with the decision to stick to the gold coverage of currencies (which had been suspended in many other countries at that time), thus denying the issue of additional money at a time when this would have been the only right course of action rather than in fact imposing devastating austerity – which contributed significantly to paving the way for fascism. 

To believers, the Wörgl experience is the irrefutable proof of concept. In reality, there was no miracle. The decisive point was that people had skills and resources, machines and infra­struc­ture, but no money. They were given money, and that was what did the trick. Without the monthly 1% demurrage, the economy would have recovered just the same or even better, as no one in Wörgl, too, was sitting in a liquidity trap and everybody was happy to work, earn money and buy the goods and services available.

The message is straight­for­ward: rather than fiddling with 'interest rates' or a levy on holding money, thus taking away people's purchasing power, simply add to their pur­cha­sing power, the more so in the midst of a crisis. Unlike in 1929 and thereafter, poli­ti­cians and central bankers were aware of this in 2008 and fortunately acted accor­dingly. But why then impose negative interest which counteracts that course?

On the ambivalence of low interest rates

The question remains why interest rates have stayed at their extremely low level for more than a decade, even though the economy has performed better than was to be feared, and why the artificial extension of low interest rates into the fictitious terrain of negative interest should achieve what even a spectacular zero interest rate has not. The structural root cause of current low levels of interest rates is an overhang of money creation from recent decades. When the money is offered as borrowed capital, but is not in demand to that extent, this depresses the level of interest rates. If the money is put in non-GDP finances, this does not raise interest rates but fuels asset inflation (see chapter in the appendix).

It is an all-too-simple idea that low interest rates are per se good for the economy, the lower the better, so to speak. Cyclically, interest rates fall when the eco­no­my is going badly, including less demand for financing. If negative interest rates then reduce pur­chasing power instead of increasing it, how can the 'eco­no­mic engine start up' and bring about a rise in prices and interest rates? Instead of imposing negative interest, it would be more appropriate to create more money directly for real-economic purposes and to raise income and expenditure across the board.

Interest rates are certainly a decisive factor in the economy, but not the sole and all-determining one. To the extent that low interest rates may invite investment, the ques­tion is what kind of investment – in GDP finances that flow into real economic supply and demand, or in non-GDP finances that do not contribute to financing real-economic output, such as second­ary trading in shares and other securities, or in real estate trading as a financial investment with rather minor implications for the con­struc­tion industry and the trades.[16]

Moreover, a business-cycle downswing at today's high levels of productivity is no need to panic and no justification for impelling people to spend money that actually they would prefer to keep, or to put it pointedly, in fact threaten the people to strip them of their money if they are not willing to spend it immediately.

The real problem today, rather than under-consumption or insufficient demand, is booms and busts in financial cycles, or financially superimposed business cycles. The basic problem behind such crisis-prone 'irrational exuberance' is out-of-control non-GDP finance fed by overshooting money creation driving too much credit and debt – a fundamental systemic problem that must be tackled, but certainly not through counter-productive negative interest. What is really needed, instead, is to regain monetary control and thus the ability to conduct effective and output-condu­cive monetary policies. The introduction and continuous spread of a digital euro by the ECB will contribute to this, negative interest nothing.

Why 'negative interest' is a misdeclaration

Negative interest has never existed in business life. The upside-down creditor-debtor relationship is fictitious model economics, a confusion of concepts. Economists who want to lend plausibility to the fiction often refer to the concept of real interest, analogous to the difference between nominal and real GDP. Real GDP is defined as nominal GDP minus the inflation rate. Similarly, 'real interest' (also called 'effective interest') is defined as an aggregate interest rate (nominal interest) minus the inflation rate. If the interest level is 5% and the inflation rate is 3%, the effective 'interest' rate is 2%. If the two rates are equal, the effective rate is zero. If the interest rate is 5% and inflation 6%, the effective 'interest' rate is -1%.

Combining two different classes of operands - income and inflation - makes sense when considering the actual-versus-nominal purchasing power of various kinds of receipts, such as, for example, earned income, interest, capital gains, transfers. But this does not make the interest rate an infla­tion rate, and the result of the calculation is neither the one nor the other, instead, the calcu­lation of a partial loss of purchasing power. In this respect, the term 'real interest' is wrong, and misleading with regard to a negative computational result as 'negative interest rate'.    

Furthermore, interest payments are always 'negative' for the payer, in that they are an expense. For the recipient of the interest, however, it is a revenue, also and especially in the case of negative interest. If the inflation rate is 3% and the negative interest rate is -1%, the payer records a loss of purchasing power of -4%, whereas the recipient records a loss of purchasing power of only -2%, because he earns 1% interest.    

The fact remains: an interest rate can at most fall to zero, but cannot become negative. In a non-manipulative, not price-administrated market, an interest rate is always positive, regardless of whether it goes into debit or credit. Someone can have a higher or lower income, or no income at all, but no negative income; rather, a deficit and debt. Breaking the zero lower bound is possible in the world of arithmetic, which extends beyond the real world. In the latter, however, interest is paid by debtors to cre­di­tors. Creditors do not pay interest to their debtors.

Independently of what has been said so far, it is misguided in the object when money balances 'bear interest'. Interest is paid on credit in the broadest sense of money being loaned or invested, not on the means of payment, neither on cash nor on account balances. Historically, there once was a reason for banks paying deposit interest on the then private banknotes as well as on bank account balances. Such bankmoney balances are also called 'credit money' for the sake of (over-)simpli­city. This is because the account balances in question are created by the central bank or a bank in disbursement of a loan or purchase of securities. Upon this, however, the account balances created this way serve as a means of payment in ongoing circulation. The principal of the underlying credit contract on the one hand and the amount of money paid out on the other hand, are the same amount, but not the same. The borrower has to repay the principal and pay interest on it.  The means of payment – the money – made available in this amount, however, is spent by the borrower und the money then circulates in a continuing chain of payments made by successive holders of that money. The successive payers and payees have nothing to do with the originary credit contract.

If any, a customer's account balance in fact represented, and in a way still represents, a cash loan from the account-holding customers to their bank. Instead of asking for pay­­ment in cash, customers over time preferred to pay cashless by bank­money trans­fer. In this respect, it was plausible for the banks to pay deposit interest to their cus­to­mers.

Today, deposit interest has largely sorted itself out. Account balances of the banks at the central bank (the reserves) and those of non-banks at the banks (the bank­money) have long since become genuine money of their own. Cash has become a sub­ordi­nate and residual exchange form for bankmoney. Soon, the customers' claim to disburse­ment of a current-account balance in cash will have become irrelevant as a matter of fact. All the more urgent is the introduction of central bank digital currency (CBDC), which will finally make non-cash central-bank money available to the general public, thus pre­ven­ting total dominance of bankmoney.

What after all is negative interest really - penalty interest, administrated loss of purchasing power, bank custody fee, passing on costs, unlawful money tax, or special levy to compensate for shrinking interest margins?

Penalty interest
If negative interest is definitely not interest, what is it? The press often uses the term penalty interest. It may indeed feel like a penalty when money is taken from you 'just like that' because you haven't already spent it. The term is out of place never­the­less. A penalty interest is a compensation payment in case a customer wants to repay a loan prior to maturity. This means that the customer is cancelling the contract at the expense of the originally agreed interest payments to the bank. Such penalty interest is not interest either, even though it is a compensation payment for a loss of interest.

A negative interest rate on account balances is nothing of the sort. After all, bank­money, which is only fractionally covered by central-bank reserves and cash, is still based on an implicit cash credit of the customers to their banks, on which, if anything, the customers could claim deposit interest. The banks can actually be glad that customers have come to terms with the inevitable use of bankmoney, because cash is no longer practical even for relatively small amounts, while non-cash central-bank money-on-account has never been available to the broad public, and CBDC is not available yet.

Administrated loss of purchasing power, artificial inflation
Already Gesell's demurrage rate ('shrinking money') was seen as an administrated shrin­kage of the purchasing power of banknotes. Since the proceeds from the sale of the value-adjustment stickers were to go to the public purse, and would have affected all money owners in the same way, it would be equally appropriate to see this as a money tax, a tax on the possession of central-bank notes.

Sometimes negative interest is seen as representing artificial inflation. But inflation it isn't. Neither the general price level nor the interest level would be directly affect­ed by the loss of purchasing power. Negative interest changes the price of money, or the price of using money, or rather not using it, regardless of whether it is treated as interest or as a bank charge. But it is handled according to the individual business policy of the banks concerned, i.e. quite differently, not the same for everyone.

Bank charge, bank custody fee
Ever more banks that charge negative interest declare it as an additional custody fee.  But what is this additional bank service supposed to consist of? Nothing has changed in account and transfer management. Nothing additional is made available, nor is any other additional service provided. Excess reserves are more than abundant. The mini­mum reserve requirement in the euro area was reduced to 1% of the relevant bank deposits during the 2008 financial crisis and has not changed since. And technically speaking, it doesn't matter to the IT apparatus whether it transfers and stores five hundred or five million euros. The costs for account management and a reasonable profit should fully be covered by the regular fees for account mana­ge­ment in general and special transfer fees in particular.

Nor is it understandable that the supposed service fee is charged as a percentage of the account balance. When did that become usual? Parking fees, warehouse charges or the price of electricity are not based on someone's monetary and financial assets. Certainly, some banks charge management fees for their customers' securities accounts as a percentage of the asset value in addition to a basic fee. Even if this is widespread, it is not really understandable, no matter how often the custodians refer to lawyers, whose fees depend to a large extent on the amount in dispute in a case.

Passing on costs
An additional custody fee remains inconsistent in other respects as well. The banks argue they are only passing on to their customers the costs the central bank demands from the banks. However, the ECB does not charge an additional custody fee, but a levy on the excess reserves of a bank at the central bank, which is declared as negative interest. The mini­mum reserves of the banks are exempt from this.

As far as the size of the payments is concerned, the rate the ECB takes from a bank and the rate that this bank takes from its customers are rarely equal in total. As long as the banks are still cautious and only charge a few customer balances a lower rate than that of the ECB, the additional revenue of the banks is likely to be less than the additional burden imposed on the banks by the ECB.

However, to the extent that the banks lose their restraint, charge ever more to all customers, and do so at a rate equal to or even higher than the ECB rate, the banks take many times more money from their customers than the ECB takes from the banks. The result depends not only on the levy rate, but above all on something else: the fact that in the existing fractional reserve system the banks' customer deposits in current, savings and time accounts are many times higher than the banks' excess reserves at the central bank.

At the beginning of 2021, the reserve balances of the euro banks at the ECB (deposit facility) amounted to € 734 billion. Customer deposits with banks amounted to 12,039 billion. Of these, about 70% are current account balances, the rest savings and short-term time deposits.[17] Assuming both the ECB and the banks were to levy the same rate (0.5% in the summer of 2021) and the banks were to levy that rate on all customer deposits, then the total amount of what the banks take from their customers would be more than 16 times higher than what the ECB demands from the banks. To put such a multiple as a simple 'passing on' of costs is a gross belittlement of the appropriation of customer money implied in the figures. This is certainly another good reason for con­su­mer associations to file lawsuits against negative interest.

Unlawful tax on money and thus a property offence
As the negative interest rate has no plausible and professionally sound basis, neither as interest nor as a custody fee nor as a simple passing on of costs, the matter remains to be treated as some sort of levy. Is the negative interest rate a disguised money tax on reserves and bankmoney?

It could be seen that way, but a 'tax' that benefits the private profit of banks or the profit of the central bank would not be legal. It is true that the banks are taken to task by the tax office as collectors of withholding tax, just as other companies are taken to task as collectors of payroll tax, value-added tax, mineral oil tax, etc. But they are not allowed to keep any of it. They are not even compensated for the effort. No one but parliaments may pass taxes and duties, no one but the respective authorities may levy taxes and duties. Municipal and state bodies may also levy other public fees. State-run central banks and the intergovernmental ECB, however – and in accordance with the separation of monetary and fiscal responsibilities – are not allowed to do so. And if they had to collect a tax on account balances (which would be a monstrosity if in addi­­tion to income tax and wealth taxes), the revenue would have to go entirely to the tax office, not into the banks' profit account.

This again raises the question as to whether the levy called negative interest is not a kind of money tax without legal basis, an expropriation of monetary property, firstly as an unauthorised grab of the ECB for the banks' reserves, then as an unauthorised grab of the banks for the customers' bankmoney, thus a property offence. In an expert opinion for a group of banks, constitutional lawyer P. Kirchhof takes such a view.[18]    

Special levy to compensate for shrinking interest margins
If the matter stands on such shaky ground in every respect, why do the ECB and ever more banks nevertheless stick to it? The advocates of low interest rates, as explained at the beginning, see it as the logical continuation of interest rate policy into new (fic­ti­tious) territory. Critics see the matter in a similar perspective, but as an impro­perly overstretched and thus distorted measure of conventional interest-rate policy, an act of helplessness in the attempt to restore the effectiveness of conventional interest-rate policy, which has largely been lost in the existing bankmoney regime.[19] If, how­ever, negative interest is definitely not about interest, then it is not about interest-rate and monetary policy. Instead, the consi­de­ra­tions developed above bring another aspect into focus: the special business purpose of the ECB and the banks to com­pen­sate for declining interest earnings due to generally shrinking interest margins by way of a special levy.

The long-term trend of falling interest rates has existed since the early 1980s. Since the crisis of 2008, central banks have intensified that trend through their policies of Quan­ti­tative Easing. The process is also known as financial repression.[20] Pushing interest rates towards zero, and even below, keeps the cost of debt artificially low, not only for govern­­­ment budgets. This allows for continued additional indebtedness and yet stabi­li­ses the price of securities concerned and thus also the financial economy in general. If then inflation is higher than deposit interest, a creeping depreciation of monetary assets is taking place. If inflation is above the interest rate on government and cor­po­rate bonds, this means a creeping redistribution of burdens from debtors to creditors. The demand for financial capital formation increases all the more, which comes along with asset inflation and financial bubble building.

The effect is exacerbated the further the zero lower bound is artificially broken into negative territory – if, for example, only minimal or no deposit interest is paid and in­stead a levy is imposed on account balances; similarly, if government bonds are issued with negative yield, that is, a loss of capital for the creditors. What is presented as negative interest or a custody fee or the passing on of costs, turns out to be a spe­cial levy imposed by the ECB on the banks, and by the banks on their customers, in order to make up for the shrinking interest margins of the ECB and the banks – a shortfall that was caused by both themselves, by excessive bankmoney creation and sub­se­quent­ly by extremely loose monetary policies of the central banks (which helped stop the crisis, but didn't eliminate its causes).

The central banks' repression of interest rates counteracts their measures to support the banks. It is not only deposit interest and refinancing rates that have fallen as costs for the banks, but also the lending rates and investment revenues the banks earn. On top of that now, in the euro area, negative interest rates have further reduced the banks' overall interest margin. 

For example, the interest margin in the lending and deposit business of German banks fell from 4.5 to 3.5 per cent from 2000 to 2011, and from then to 2 per cent by 2020.[21] Over the past ten years, earnings from interest rates have fallen from around 75 billion euros to less than 65 billion.[22] Since 2010, operating revenues of the banks have decli­ned from €132bn to €119bn. On the other hand, the credit institutions were able to increase their commission surpluses from around 27 to over 31 billion euros. This is offset by a slight increase in administrative expenses.[23]

Basically, this confirms the view of negative interest as a special business levy to offset falling interest revenues. However, the decline in such revenues has not been dramatic or even threatening the existence of the banks. But even if one wants to understand it in this way, that makes that kind of levy neither legitimate nor acceptable. It re­mains a levy of doubtful legitimacy and lawfulness. There is no coherent business reason for charging a negative interest rate on account balances or a negative yield on bonds and other types of debt. No economy can thrive in such an upside-down busi­ness world. If, however, banks come to the conclusion that they have to charge higher fees for the management of their customers' accounts and transfers, then they should do so by regularly amending their general terms and conditions. This also and espe­cially applies to the ECB. How far the banks would get with this in the market remains to be seen. Competition from ‘shadow banks’, other financial inter­me­dia­ries and payment services continues to challen­ge the business models of traditional banks.

Now what?

Whichever view on negative interest may ultimately prevail, it is basically clear to all parties involved that such a problematic levy cannot last for too long. The central banks every so often state that they intend to return to normal interest rates as soon as circum­stan­ces permit. What circumstances prohibit doing so?

There is concern that a noticeable rise in interest rates will trigger a severe debt crisis due to the high debt levels accumulated by most governments and also quite a few companies. This in turn may cause the newly forming bubbles in real estate and stocks to implode, resulting in another major financial crisis which the measures taken were supposed to prevent. Central banks, banks and other financial actors have apparently painted themselves into a corner from which they cannot get out cleanly. As for the ECB, its first step should be to end the mischief called negative interest. When interest-rate policies don’t work anymore, or an outdated business model is no longer competitive, this is not an accep­table justification for pursuing a counter-productive and possibly unlawful practice.

Second, the feared debt crisis can be avoided by neutralising sovereign debt. This can be done by the central banks, which already hold between a quarter and half of public debt (the ECB a third), continuing its bond purchases on the open market. The claims and lia­bi­li­ties in question, instead of being redeemed at maturity, are to be conso­li­dated on the central-bank balance sheet for an indefinite period of time by converting them into zero-coupon perpetual consols.[24] The zero interest rate follows from the fact that interest payments by the treasury to the central bank flow back to the treasury as part of the central bank profit. Such shifting back and forth is dispensable. The non-limitation of the bonds opens up room for man­oeuvre. Over decades, debts are consi­de­rably relativised even by low inflation rates.

Third, under the condition of largely neutralised public debt, the policy of financial repression can be ended. The ECB as well as other central banks can then do their part to raise interest rates to historically normal levels. Announced by forward guidance, central-bank interest rates would be raised over a longer period of time by small and steady steps that do not worry anyone.  

Fourth, it would greatly improve transmission and thus the effectiveness of monetary policy if central banks were to abandon their currently still hesitant and defensive attitude towards introducing central-bank digital currency (CBDC). The more CBDC in general circulation, the stronger the transmission lever of monetary policy. Such non-cash sovereign money – a digital dollar, euro, pound etc. – should actively be disseminated as soon as technically possible, as legal tender for everyone, without artificial limits on availability and uses.[25] The monetary system is undergoing profound changes. In such a situation, backward-looking insistence on old habits can only be detrimental.

Appendix.
Why has the level of interest rates been so low? The overhang in money and capital, called savings glut – the structural root cause of depressed interest rates

According to a widespread assumption, central banks control the level of interest rates according to their monetary policy objectives. This is largely a myth, and a rather double-edged one at that. Central banks can only set interest rates on central-bank money (cash and reserves). The smaller the share of central-bank money in the total active money supply, the smaller the control effect exerted by central-bank interest rates. Overall, central banks follow the prevailing trend much more than they deter­mine it.

The long-term trend in interest rates prevailing today arises from the global so-called savings glut. The continued decrease in CPI and interest rates from around 1980 is commonly attributed to globalisation in that it included strong competition from low-cost pro­ducts from low-wage countries as well as weakened bargaining power of the unions. Another equally decisive reason was the parallel shift towards global financialisation. At the beginning that shift was based on much-increased industrial wealth, while later on it was increasingly based on 'credit money' creation for financial leverage, including credit and debt bubbles in real estate and housing.

The development was, and still is, based on the dynamics of second-level bankmoney creation, fractionally refinanced by base-level central-bank reserves, and multi­plied by third-level MMF shares and other new money surrogates; all used at an accelerating velocity of the finan­cial circulation of money due to new securitisation practices. GDP-dis­pro­por­tio­nate growth of money and credit, rather than boosting real-economic CPI thus fed asset inflation and bubble building. As an entrenched pattern, this indi­cates 'too much finance'[26], more precisely, too much non-GDP finance, which does not help finance real-economic output, as opposed to GDP finance, which finances real-economic output. 'Too much finance' inclu­des a bias towards financial income to the detri­ment of earned income.

What is harmlessly called 'savings glut' is in actual fact a glut of financial excess capital chasing non-GDP contributing investment opportunities, in other words, over-abun­dant supplies of money and credit, producing a demand market that depresses interest rates. Over-abundant money creation for finance thus creates the single most im­por­tant condition for a continued series of financial booms and busts.[27]

As the last sharp reduction in central-bank base rates was made in the hot phase of the banking and debt crisis of 2008–12, the crisis was taken to be the cause of the reduc­tion.[28] This is not wrong, but falls short. The crisis, as well as the decline in CPI and interest rates, was caused by the secular mega-bubble, which is rheto­ri­cally belittled as 'savings glut'. Once more, central banks could not help but follo­w and add to the disinflationary and even deflationary tendencies by sharply cut­ting the base rates and creating an additional flood of money supply through QE. This further enlarged the 'savings glut' and lowered interest rates all the more.

What weakened base-rate policies can no longer achieve is easily accomplished by the unconventional measures of QE, that is, by massive quantity policy supporting the maintenance of financial assets. The result, though, is deliberate interest-rate repress­sion, resulting in sub­opti­mal economic development and also including a degree of wage repression. At the same time, the money, credit and debt 'glut' is still the main obstacle facing central banks in their attempts to return to normal.

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Arcand, Jean-Louis / Berkes, Enrico / Panizza, Ugo. 2012. Too Much Finance? IMF Working Paper, WP/12/161, June 2012.

Assenmacher, Katrin / Krogstrup, Signe. 2018. Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money, IMF Working Paper, WP/18/191, Aug 2018.

Atkinson, Anthony B. 2015. Inequality. What can be done? Cam­brid­ge, MA: Harvard University Press.

Ball, Lawrence / Honohan, Patrick / Gagnon, Joseph / Krogstrup, Signe. 2016. What Else Can Central Banks Do?, Geneva Report on the World Economy No. 18, ICMB and CEPR.

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Bordo, Michael D. 2018. Central Bank Digital Currency. The Future Direction for Monetary Policy? Shadow Open Market Committee, E21 Manhattan Institute, March 9, 2018, http://shadowfed.org/wp-content/uploads/2018/03/BordoSOMC-March2018.pdf.

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Buiter, Willem H. 2009. Negative Nominal Interest Rates. Three ways to overcome the zero lower bound, NBER Working Papers, June 2009.

Buiter, Willem. H. / Panigirtzoglou, Nikolaos. 2003. Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell’s Solution, The Economic Journal, 113: 723–746.

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Deutsche Bundesbank. 2020. Die Ertragslage der deutschen Kreditinstitute im Jahr 2019, Monatsbericht Sept. 2020, 75–105

Deutsche Bundesbank. 2020b. Entwicklungen im deutschen Bankensystem in der Negativzinsphase, Monatsbericht Okt. 2020, 15–40.

Diaz-Alejandro, C.F. 1984. Good-bye financial repression, hello financial crash, Kellogg Institute working paper, no. 24, August 1984.

Dohms, Heinz-Roger. 2020. 15 Erkenntnisse zum Zustand der deutschen Bankenbranche, finanz-szene.de, 22 Sep 2020. https://finanz-szene.de/banking/15-erkenntnisse-zum-zustand-der-deutschen-bankenbranche.

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Endnotes

[1] Rogoff 2017.                                          

[2] Buiter/Panigirtzoglou 2003, Buiter 2009, Rogoff 2017.

[3] Aday 2021. https://www.verivox.de/geldanlage/themen/negativzinsen.

[4] Jurkšas 2017 27, IMF 2017 14–26.                              

[5] In the 1920s and the first half of the 1930s, there was a stamp scrip movement in continental Europe and America, to which Irving Fisher adhered before adopting the reform approach of 100%-money, that is, a 100% reserve consisting of cash and central-bank reserves as full coverage of the banks' deposit money.

[6] Esselink/Hernández 2017, Krueger/Seitz 2014 7, Rogoff 1998.

[7] Among the supporters of abolishing cash are Svensson 2003, Buiter 2009, Rogoff 2014, Ball/Honohan/ Gagnon/Krogstrup 2016.

[8] Barrdear/Kumhof 2016, Kumhof/Noone 2018, Sveriges Riksbank 2017, 2018.

[9] For example Agarwal/Kimball 2015, Rogoff 2017, Bordo/Levin 2017 3, Bordo 2018 3. 

[10] IMF 2018 4, 29.

[11] Assenmacher/Krogstrup 2018.

[12] IMF 2017. Jurkšas 2017. de Sola Perea/Kashama 2017.

[13] de Sola Perea/Kashama 2017 47.

[14] Buiter 2001 pp.32, Buiter/Panigirtzoglou 2003.

[15] Broer 2007, Lietaer 1999 ch.5.               

[16] See Ryan-Collins/Lloyd/Macfarlane 2017. Also https://sovereignmoney.site/the-hemispheres-of-finance.

[17] Deutsche Bundesbank, Monthly Report, April 2021, Data from statistical tables II.2 und III.2.  

[18] Roberts 2021, Adey 2021, Köhler 2015.

[19] Also see Palley 2016.

[20] The notion of financial represssion, or interest-rate depression, as a result also wage depression, originates from Shaw 1973 as well as McKinnon 1973. Also cf. Reinhart/Sbrancia 2011, Diaz-Alejandro 1984, Hoffmann/Zemanek 2012, Smith 2014, Schnabl 2014.

[21] Deutsche Bundesbank 2018 56, 2020b 29.

[22] Deutsche Bundesbank 2020b 29f.

[23] Deutsche Bundesbank 2020 88, 90. Dohms 2020.

[24] https://sovereignmoney.site/monetary-financing-of-government-expenditure

[25] https://sovereignmoney.site/sovereign-digital-currency.

[26] Arcand/Berkes/Panizza 2012. Atkinson 2015 18–19, 82–109.            

[27] For theories of financial cycles more or less detached from business cycles see Borio 2012, 2017, Borio/ Hof­mann 2017, Shiller 2015, Minsky 1982, 1986

[28] For example Assenmacher/Krogstrup 2018.