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Payback - There is more than one way to avoid negative interest rates

2016-01-14 10:59:35

Jan 13th 2016, 15:03 by B.L. | LONDON

Economists often think that cash is to blame for the zero lower bound. Official

interest rates can't fall far below zero because, the argument goes, people

would hoard cash rather than pay to keep money in their deposit accounts. That

has led some policymakers to suggest abolishing cash. In fact, hoarding

banknotes isn't the only way for depositors to get around negative interest

rates, as a story in yesterday's Financial Times shows. People can instead

start paying bills early.

Businesses usually like early payment, and sometimes offer discounts to

encourage it. Many tax authorities, too, offer discounts to those who pay in

advance and charge interest to those who pay late. Not so in Zug, Switzerland,

where the logic of negative interest rates has turned payment behaviour

upside-down. The canton once offered a small discount to people who paid their

tax bills early. Now, early payment is unwelcome, as it means the canton must

pay a charge for holding the cash. To reduce the number of early payments, the

canton has abolished the discount. It has even stopped charging interest on

overdue tax bills.

Zug's behaviour shows that there is more than one way to avoid negative

interest rates. Holding cheques without depositing them has the same effect as

pre-paying bills and taxes. Hoarding train tickets, vouchers or gift cards

works too. Paul Donovan, an economist at UBS, argues that companies are

stocking up on inventories and lending money to their customers in order to

avoid holding bank deposits. As long as it does not depreciate, holding surplus

inventory makes sense when interest rates turn negative. In fact, holding more

or less anything that has a fixed price is beneficial though one downside to

such a strategy is that these items, unlike bank deposits, do not benefit from

a government guarantee.

These examples show that it isn't just the existence of cash which generates

the zero lower bound. There are numerous ways in which bank depositors could

push the cost of negative rates off onto others. It is true that, in time, some

of these loopholes could be closed. More suppliers could start charging for

early payment, and the issuers of gift cards, train tickets and other

pseudo-currencies could incorporate an interest rate into their pricing. But as

John Cochrane, a professor at the University of Chicago, notes, our legal and

financial system "deeply enshrine the right to pay early." Getting rid of these

loopholes might be every bit as difficult as getting rid of cash.