The ECB – Departing Into the 'Twilight Zone'?

A recent Bloomberg article discusses the 'tools' left in the ECB's inflationary toolbox in order to combat the deleveraging cycle in the euro area. Allegedly Mario Draghi is about to take leave of the euro-zone in order to 'enter the Twilight Zone', a fabled territory of nutty monetary experimentation not even Heli-Ben dares to frequent.
“European Central Bank President Mario Draghi is contemplating taking interest rates into a twilight zone shunned by the Federal Reserve.....

Few central bankers dare to venture in to the Twilight Zone…but Mario Draghi may 

While cutting ECB rates may boost confidence, stimulate lending and foster growth, it could also involve reducing the bank’s deposit rate to zero or even lower. Once an obstacle for policy makers because it risks hurting the money markets they’re trying to revive, cutting the deposit rate from 0.25 percent is no longer a taboo, two euro-area central bank officials said on June 15.....

Should Draghi elect to cut the deposit rate to zero or lower, he’ll be entering territory few policy makers have dared to venture. Sweden’s Riksbank in July 2009 became the world’s first central bank to charge financial institutions for the money they deposited with it overnight. The Fed rejected cutting its deposit rate from 0.25 percent last year. With Europe’s debt crisis damping inflation pressures and curbing growth, the ECB may feel the benefits outweigh the negatives.”

Yes, there actually is such a thing as central bank-administered negative interest rates. The so-called 'zero-bound' is not relevant for the central bank's own deposit facilities, where the excess reserves of commercial banks are parked (these reserves and the currency issued by the central bank represent the vast bulk of its liabilities).

We would note to this that not even a negative deposit rate will induce banks to lend out money by pyramiding deposits upon their reserves if their fear of loss of capital is great enough. We doubt the big German banks would suddenly fall over themselves to lend to credit-starved Greeks or Spaniards, for instance, just because they might have to pay a ¼ point penalty. After all, in Switzerland the entire yield curve up to the five year note has turned into negative territory recently.

If on the other hand the penalty rate becomes large enough (i.e., if the interest rate on central bank deposits is moved deeply enough into negative territory) to actually induce the banks to create new loans and deposits, then there is no telling what could happen in view of €830 billion in excess reserves considering the paltry reserve requirement of 1% (!) for demand deposits in the euro area. In theory, the banks could lever up their reserves by a factor of 100. We don't expect that to happen, we're merely pointing out that it would be possible in principle. So this has to be one of the more crazy ideas out there, since if it doesn't work, it will only reduce the liquidity buffers of banks, whereas in case it does work, it could kick off a major inflationary episode. That doesn't mean it won't be tried. In fact, this particular Bloomberg missive on the topic may be a 'trial balloon' leak in order to find out how the idea is received.

Meanwhile, Chicago Fed president Charles Evans is once again calling publicly for more money printing on the part of the Fed, so the two central banks could perhaps start a competition. Best hang on tight to your gold...........

                                    .....................Pater Tenebrarum