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Counting backwards

18 December 2014 By Edward Hadas

There are some unlikely ideas in both mathematics and finance. For example, the square root of negative numbers and negative interest rates both look impossible. To make sense of them, it is necessary to understand numbers and money in a new way. The Swiss National Bank has put the deeper monetary theory into practice, by cutting its overnight policy rate to -0.25 percent on Dec. 18.

The central bank is trying to keep Switzerland neutral in the global currency wars. With other countries trying to push down the value of their currencies, traders are desperate for safety. The franc is considered a haven, and the demand constantly threatens to push up its value well past the level at which the Swiss can trade their goods and services profitably.

The SNB had already responded. Its first tool was the printing press. In September 2011 it promised to create enough new francs to sell to foreign investors to keep the currency’s value below 1.20 to the euro. That has worked, but the stable value has loaded the SNB with an uncomfortably large $475 billion of reserves. Negative interest rates are a new tool.

In everyday life, where money is considered a way to hold onto future purchasing power, that sounds crazy. When people look at money as a store of value, they don’t want that value wilfully cut by the monetary authorities.

But the SNB sees money quite differently, as a tool of both macroeconomic policy and financial speculation. Speculators do not care about steady currency values or Swiss jobs. They want to reap gains and avoid losses. The central bank does care about Swiss jobs, which it believes are threatened by an out of control franc. So it uses money to fight against financial market abuse.

The SNB is not the first central bank to try negative rates, but it seems to be the most determined, suggesting rates could fall to -0.75 percent. Other monetary authorities should study this experiment carefully. Like the imaginary numbers of mathematics, the inverted-savings of negative rates can be a vital tool in a time of deflation.

 

 

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