Aswath Damodaran on negative rates

In one of his rare excursions into macro matters, Professor Aswath Damodaran has written a long post on negative rates. If it is the first time you are hearing about negative interest rates, it is a MUST READ.

This blogger has blogged on this incessantly. Some samples here:

Bernanke blogs (April 2015)

Chained to zero (September 2015)(

Checking out of hotel ZIRP  (September 2015) (

Deficient demand or excess supply  (October 2015) (

Educating Larry Summers  (November 2015) (

Messianic or moronic (February 2016)

Feigned or real (February 2016) (

Coming from Professor Aswath Damodaran, these messages acquire far greater legitimacy and respectability. Some extracts from his (long) post:

Turning to the question at hand, is it possible for nominal interest rates to be negative, based upon fundamentals? The answer is yes, but with a caveat. If the preference for current consumption over future consumption dissipates or gets close to zero and you expect deflation in a currency, you could end up with a negative interest rate.

He is right. It is also important to understand the ‘signalling effect’ of negative interest rates. It is true that we end up with a negative interest rate when we expect deflation in the country (or, currency, as he says). More importantly, central bankers convey that their expectation is for ‘deflation’ when they push interest rates below zero. They send a signal which is opposite to what they seek to achieve (higher inflation rate).

… negative interest rates signify economies with low or no real growth combined with deflation and the growth rate in perpetuity for stable companies in these economies should be negative for those same reasons.

That is an important point for market valuation of stocks. Growth rate in perpetuity is negative for companies in these economies.

His conclusions on the consequences of low interest rates are impeccable. I am glad that he mentions the law of unintended consequences for that has been the pet peeve of this blogger:

When interest rates of from being really small positive numbers (0.25% or 0.50%) to really small negative numbers (-0.25% to -0.50%), the mathematical consequences are small but I do think that breaching zero has consequences and almost all of them are negative.

The economic end game: For those who ultimately care about real economic growth and prosperity, negative interest rates are bad news, since they are incompatible with a healthy, growing economy.

Central banks insanity, impotence and desperation: As I watch central bankers preen for the cameras and hog the limelight, I am reminded of the old definition of insanity as trying the same thing over and over, expecting a different outcome. After six years of continually trying to lower rates, with the expectation of economic growth just around the corner, it is time for central banks to perhaps recognize that this lever is not working. By the same token, the very fact that central banks revert back to the interest rate lever, when the evidence suggests that it has not worked, is a sign of desperation, an admission by central banks that they have run out of ideas. That is truly scary and perhaps explains the rise in risk premiums in financial markets and the unwillingness of companies to make real investments. [Emphasis mine]

Just imagine what the European Central Bank did on Thursday,  Mar. 10, 2016. If banks wish to deposit money with ECB, they would pay interest to ECB. If banks were to borrow from ECB, ECB would pay them interest (under certain conditions). The theory and practice of interest rates turned on its head!

Unintended consequences: As interest rates hit zero and go lower, there will be some investors, in need of fixed income, who will look in dangerous places for that income. A modern-day Bernie Madoff would need to offer only 4% in this market to attract investors to his fund and as I watch investors chase after yieldcos, MLPs and other high dividend paying entities, I am inclined to believe that is a painful reckoning ahead of us.

An opening for digital currencies: In a post a few years ago, I looked at bitcoin and argued that there will be a digital currency, sooner rather than later, that meets the requirements of trust needed for a currency in wide use. The more central bankers in conventional currencies play games with interest rates, the greater is the opening for a well-designed digital currency with a dependable issuing authority to back it up.

I hope Martin Sandbu, Martin Wolf, Larry Summers, Wolfgang Muenchau and Ken Rogoff  ((just to name a few) read his post. Perhaps, I should commend his blog post to Gavyn Davies too for these two posts of his.

How could I have left out Narayan Kocherlakota? The man with such brilliant clairvoyance on the utility and effectiveness of negative interest rates!


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