The problem with the European Central Bank’s recently announced plans to charge a negative interest rate on deposits might not be that it goes too far, but that it doesn’t go far enough. The unusual step — consumers would pay banks for holding their money, rather than the other way around — is necessary to head off perilously low inflation of 0.5 percent in the euro zone.
Europe remains mired in sluggish growth and large unemployment rates as a result of austerity policies, but the economic condition would go from bad to worse if the inflation rate fell below zero. Economists warn that the resulting deflationary spiral would lower prices, hiring and profits, further weakening the European economies. Japan spent nearly two decades trying to escape the debilitating effects of deflation and still hasn’t fully emerged.
Nonetheless, a negative interest rate is an exotic option for central bankers to use, especially on such a large scale.
The unorthodox strategy is a consequence of the ECB’s limited options in fighting off recession, since it cannot easily run a large quantitative easing program that directly injects money into the economy like the U.S. Federal Reserve did. But by encouraging lenders to invest their money in private businesses rather than resting on their reserves, the ECB’s negative interest rate would generate a similar effect.
Staving off a double-dip recession ought to be Europe’s priority — and a negative interest rate might just be the jolt that the euro zone needs to remain afloat.