Term of the Day: Negative Deposit Rate

Last week the European Central Bank (ECB), in an unprecedented move, turned the deposit facility interest rate negative.

So, what?

Well, this means that the money that banks park in the ECB in excess of their reserve requirements will now be 'taxed' at a rate of 0.10 percent. The rationale behind this move is to light a fire under the banks to deploy the capital in the real economy. Is it flawed? Yes, deeply. It is more likely that as an alternative to deploying this capital in a constructive manner that the banks will use it in a way that promotes fragility (e.g., one of the many asset bubbles du jour). It is likely that more and more banks will reduce their deposits in excess of their reserve requirements in the coming months.

There will be unforeseen consequences. The more control they attempt to exert over the monetary system the more fragile it will become, leaving them with fewer policy options when the next crisis arises.