The new plan by the European Central Bank to charge a negative interest rate on deposits doesn’t go too far. In fact, it doesn’t go far enough.
The unusual step of requiring consumers to pay banks to hold their money, rather than the other way around, is needed to head off perilously low inflation in the euro zone. Europe remains mired in sluggish growth and high unemployment because of austerity policies, but its economic condition would get even worse if its inflation rate fell below zero.
Economists warn the resulting deflationary spiral would lower prices, hiring, and profits, further weakening European economies. Japan spent two decades trying to escape the debilitating effects of deflation, and still hasn’t fully emerged.
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 bank’s limited options in fighting off recession.
It cannot easily run a large quantitative-easing program that injects money into the economy, as the U.S. Federal Reserve did. By encouraging lenders to invest in private businesses instead of hoarding their reserves, the negative interest rate may generate a similar effect.
Staving off a double-dip recession ought to be Europe’s priority. A negative interest rate might be the jolt the euro zone needs to remain stable.