It is the biggest monetary policy experiment of modern times. One that has divided economists, central bankers and politicians. But now that Sweden has called a halt to its five-year trial with negative interest rates the serious work has begun on looking at whether it worked.
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Sweden's Riksbank, the world's oldest central bank, was the first to take its main repurchase rate — at which commercial banks can both borrow or deposit money — negative in early 2015, to fend off deflation, only returning to zero in December.
The end of the Swedish experiment is being watched with intense fascination, not just by those central banks that still have negative rates such as the European Central Bank and Bank of Japan, but also by authorities and economists worldwide pondering how to respond to the next downturn with limited ammunition to stimulate the economy.
For many, it is still too early to judge whether negative rates have worked or caused lasting damage to the economy and finance sector. But, Jakob Carlsson, chief executive of the Swedish life insurer Lansforsakringar Liv, is in no doubt. He calls sub-zero rates "a mistake", arguing that they force people to save more and spend less. "Sooner or later, we will have to pay the bill for this experiment of artificially created negative rates," he says.
Eurozone banks say they have paid €25 billion ($42.6b) in negative rates to the ECB since it cut rates below zero in June 2014, eating into their already weak profits. Other areas of finance have also felt the strain — Dutch pension funds, only narrowly avoided cutting payouts to pensioners last year after the government intervened to loosen rules.
"The ECB, the US Federal Reserve and the entire central bank community are watching very closely what is happening in Sweden, it is an interesting empirical example," says Guntram Wolff, director of the Bruegel think-tank in Brussels.
"The real question is whether a change in interest rates from negative to zero has an impact on inflation and economic growth."
Negative rates turn the principles of finance on their head by forcing commercial banks to pay to store money at the central bank rather than earn interest on it. At the same time, some countries and companies have been paid to borrow. Most recently, some individuals across Europe have begun paying to deposit large sums of money in banks, while mortgage borrowers in Denmark have received money from their house loans rather than having to pay interest.
The idea behind the topsy-turvy policy is to encourage banks to lend more money instead of holding it at the central bank, thus stimulating the economy by also lowering financing costs for companies and households. Denmark, the eurozone, Japan and Switzerland still have negative rates but the evidence on whether they work — and with what side-effects — is still being collected.
The ECB, which last year cut its deposit rate to a new low of minus 0.5 per cent, argues that without its actions the eurozone economy would today be almost 3 per cent smaller and have 2m fewer jobs. "Clearly everybody is going to look at what conclusions are drawn from that monetary policy reversal . . .
in Sweden, but I wouldn't draw any conclusions as far as our policies are concerned," Christine Lagarde, president of the ECB, said in February.
Lagarde has, however, promised to study the side-effects of negative rates, as part of a strategic review of monetary policy. "The longer our accommodative measures remain in place, the greater the risk that side-effects will become more pronounced," she told the European Parliament.
Stefan Ingves, governor of the Riksbank, argues that negative rates have been a success in Sweden. But he accepts that had they continued indefinitely they could have had a detrimental impact, raising questions about their future value to policymakers.
The Riksbank introduced sub-zero rates in 2015, not due to weak growth — gross domestic product increased that year by 4.4 per cent in the EU member state — but because of the risk of deflation. Inflation dipped briefly below zero in 2014 and only returned to the Riksbank's 2 per cent target at the end of 2017 when Sweden's repo rate stood at a record low of minus 0.5 per cent.
"Inflation actually came back. So in that respect, going negative made the whole thing work," Ingves says, stressing that quantitative easing — government bond-buying — also helped. "The issue for us hasn't been to stay negative for longer than we needed to".
The Riksbank has been here before. Its 2010-11 decision to raise interest rates after the financial crisis was closely scrutinised. On that occasion it reversed course and cut rates again soon afterwards, drawing charges of "sadomonetarism" from Nobel-prize winning economists and inspiring the Fed to slow its monetary tightening.
Now, there are questions being asked again after the Riksbank raised rates while the Swedish economy is slowing and inflation falling. Ingves is clear that in a world wracked by economic uncertainty, "if the choice were to be at zero or slightly negative, to be at zero is a good place to be".
He argues that as Swedish growth has been stronger in recent years than the eurozone's "it is not all that strange that we slightly distance ourselves from the eurozone".
Yet, some economists argue that the Riksbank may be forced to return to negative territory if the economy weakens or the sharp drop in inflation — the annual rate fell from 1.7 per cent to 1.2 per cent in January on the back of low energy prices — intensifies.
After five years of running a negative rates policy the Riksbank governor identifies several areas where, he believes, they could cause long-term problems. Top of the list is the banking system, where critics claim negative rates could weaken already struggling institutions, discouraging lending and prompting savers and companies to hoard cash.
As a byproduct, Dietmar Schake, sales director of Burg-Wächter, says Germany's largest safe manufacturer has benefited from a one-third increase in sales since the deposit rate at the ECB went below zero. "Customers prefer to keep their money at home rather than in their bank accounts, where negative interest rates are threatening," he adds.
Ingves says Sweden's banks have coped better than those in the eurozone because a lack of bad loans and lower costs mean their return on equity has stayed relatively high.
But even here there is now relief. Johan Torgeby, chief executive of one of Sweden's largest banks SEB, says lenders involved in fixed income "struggled for years" and calls the end of sub-zero rates "good news". He adds: "We have never really understood what effect negative yields have on [boosting] consumption."
He is not alone. One of the reasons the Riksbank gave for its decision to end negative rates was that the public struggled to understand the policy and thought it "strange".
Banks provide 80 per cent of loans to European companies and households, making them the main channel to transmit interest rate policy into the wider economy. The Association of German Banks said in a recent report that negative rates had cost eurozone lenders a total of €25b since they were introduced. "This burden is depressing the profitability of the banks and will ultimately even constrain their lending capacity," it warned.
Much of the debate about negative rates hinges on the idea of a "reversal rate" below which lending activity by banks is subdued and starts to fall.
Research published last year by Princeton University economists Markus Brunnermeier and Yann Koby found that many of the benefits of negative rates are front-loaded — such as gains in asset prices on bank balance sheets — while the corrosive side-effects last longer.
Bank lending in the eurozone was, however, shrinking when the ECB first cut rates below zero in 2014 and has since rebounded. Household lending is up more than 12 per cent since negative rates started, while corporate lending has grown 3 per cent. The ECB has also taken action to soften the blow for the banking sector, including a "two-tier" deposit system that exempts some of the money it holds for banks from negative rates, while also offering them loans at sub-zero levels to stimulate lending.
Among the big losers have been savers. With more than US$13 trillion ($20.5t) of bonds trading at negative yields, a growing number of pension funds, insurance companies, and banks are struggling to generate sufficient returns, raising doubts over some business models.
Ingves acknowledges that Swedish insurance companies are heavily exposed to stock markets, unlike many of their European rivals. While shares have gone up, that has been good news. "But if the stock market is down at some time in the future, then risks are going up, and that increases risk in the system as a whole," he adds.
Isabel Schnabel, a German economist who recently joined the ECB board, says that criticism of its monetary easing policies in her country "is all too often combined with claims and accusations that have no basis in fact". While the average German saver is €500 out of pocket because of negative rates, Schnabel says an average borrower is €2,000 better off and the overall gains outweigh the losses, with Berlin saving billions of euros on interest payments.
Another risk from negative rates is that they inflate asset price bubbles, while also keeping alive zombie companies that without cheap money would collapse. In Sweden, the big concern has been the housing market, with Ingves repeatedly issuing warnings about record levels of household debt.
A series of measures to make mortgages harder to access have eased Swedish fears. The Riksbank recently changed its outlook on rates. Even when they were in negative territory, it always forecast increases. But in December, it said rates would remain at zero for years until, in the words of Ingves, "the fog lifts" and there is a clearer view of the global economy.
Gabriel Blir, an estate agent in central Stockholm, talks of the struggle he had to sell a flat bought near the peak of the market in 2016 for SKr4.5m. Two earlier attempts failed when bids went no higher than SKr4.2m but this month, after the Riksbank's comments on rates, the flat was snapped up for SKr4.45m (€420,000).
"When you hear that interest rates will stay low for years, it is a big safety net for buyers," he says.
Such anxieties feed into the larger debate over the efficacy of negative rates. "There is an increasing realisation that the negative side-effects of these policies are becoming more apparent . . . while the benefits in terms of raising inflation to central banks' targets have not been achieved," says Danae Kyriakopoulou, chief economist at central banking think-tank OMFIF.
Policymakers at the ECB seem committed to sub-zero rates in their quest to lift inflation. "The overall macroeconomic effect of unconventional measures remains positive . . . there may be diminishing returns from negative rates, though we are not yet close to the reversal rate," says Olli Rehn, head of Finland's central bank and a member of the ECB governing council. "If needed, we have capacity to cut further."
Ingves appears less sure of the use of negative rates in the future. He underscores that they could indeed go below zero in Sweden again if the economy deteriorates, but he stresses that in a sharp downturn additional policies would have to take more of the strain.
"I think there actually is a lower bound for the policy rate," he says, adding that he finds it difficult to envisage a rate of, say, minus 5 per cent. Instead he argues the central bank would have to use its balance sheet more. So too would the government, whose debt is forecast to fall to close to 30 per cent of GDP this year, low by European standards.
His comments echo those of Lagarde, who said in February: "Monetary policy cannot, and should not, be the only game in town".
Central bankers are closely monitoring how Sweden fares in its move to zero rates as the outlook for growth and inflation both there and in the rest of the world remains uncertain.
"We look forward to a day when we can get out of negative rates," says Philip Lane, chief economist of the ECB. "At some point, the comparison of benefits and costs is going to change . . . It is a lot easier to make that decision when inflation is closer to 2 per cent, as in Sweden, than when it is still too far away, as it is here [in the eurozone]."
Negative rates: A brief history of extreme monetary policy
The European Central Bank cuts its deposit rate below zero for the first time to -0.1 per cent.
The Swiss National Bank cuts its deposit rate into negative territory for the first time to -0.75 per cent.
The Riksbank becomes first central bank to cut its repo rate below zero while Danish deposit rates hit a world-record low of -0.75 per cent.
Japan introduces a negative interest rate for the first time of -0.1 per cent.
Norway cuts rates to a record low of 0.5 per cent, but never goes negative and starts hiking again in 2018.
The total amount of negative yielding debt peaks at US$17t.
Denmark's Jyske Bank offers a 10-year mortgage at -0.5 per cent but also imposes negative rates on some rich individuals' deposits.
US president Donald Trump calls on the Federal Reserve to cut interest rates to zero or below to enable the country to refinance its debts more cheaply.
Written by: Richard Milne and Martin Arnold
© Financial Times