Negative Interest Rates and the Fed: Just a Matter of Time

DALLAS—Federal Reserve Chairman Janet Yellen recently reiterated that interest rates may rise this year, although that timetable seems to keep lengthening. The economy remains soft and uncertain, so who knows if and when a hike will occur? And what if business conditions turn sour and a recession beckons, what would monetary policymakers do then? 

What we do know about Fed policymakers is that they won't sit on their hands and ignore their mandate to support stable price levels and full employment, even in a high debt, low interest-rate environment. Basically, I believe they would have four primary options.

First, they could restart some sort of quantitative easing to flatten the long-end of the yield, or interest rate, curve. This is a no-brainer and consistent with their past practices when they bought Treasury bonds and mortgage-backed securities to spur the economy. Think of what impact a 1%, 30-year home mortgage could potentially have on both the wealth effect via home prices and affordability for first-time home buyers. However, I believe this alone would not impact the economy enough to lift us out of recession.

Second, they could expand their asset purchases to physical assets, not just financial assets.  They could purchase and build billions upon billions of hard assets such as roads, bridges and other infrastructure. This would spur the hiring of thousands of construction workers.  While public works is a traditional way to stimulate the economy, having the Fed finance it directly rather than the Federal government would be quite unusual.

Third, the Fed could mail a debit card to every adult in the country, putting say $100 a month on the card and instructing us that if we don't spend it, the money will be withdrawn. This will certainly stimulate the economy, if not also highly unconventional.

I believe the fourth option they may well consider doing is something they've never done before: Adopt a negative interest rate policy (“NIRP”)—taking the short interest rate heavily into negative territory. Many people find this scenario unlikely, but I don't believe it's a farfetched idea at all.

As a matter of fact, I believe NIRP to be the easiest and most logical path for the Fed to follow. In one sense, it is the path of least resistance for the Fed since it's not difficult for the policymakers to cut rates although now they'll probably do it by materially lowering, into negative territory, the rate paid on excess bank reserves. In nearly every recession, policymakers lower short rates, such as the rate banks charge each other for overnight loans to stimulate the economy and cushion the economic fall. Reducing the short rate makes money cheaper, increases asset values, and promotes credit growth, which is the lifeblood of the economy.

While there has undoubtedly been a historical stigma and confusion around the idea of negative interest rates, it is rapidly disappearing as they quickly are becoming the norm elsewhere around the globe. Since 2014, for example, several European economies have adopted them to try to recharge their economies.  Some argue that NIRP can be easily thwarted by individuals, firms, or ETFs accumulating large amounts of cash currency that won't carry this negative interest rate.  However I believe this arbitrage can be easily thwarted by having the Treasury print bills no larger than $20s to make storage of currency extremely expensive, and letting banks charge hefty fees for cash currency withdrawals above say $3,000 per month.

Our executive team at Ashford, a real estate-focused asset management firm, spends a lot of time on economic scenarios to determine how best to protect our assets. Before the recession in 2008, we perceived potential recessionary risks and moved to put what we believed to be attractive interest rate hedges in place to protect the value of our assets.  We figured the Fed would, as usual, trim short interest rates in a downturn—then close to 5%—we would realize substantial interest expense savings as a result. We did.

While we are not calling for a recession in the near future, we believe that it is important as an asset manager to constantly be contemplating scenarios and asking hard questions. This is a question that we've been wrestling with quite a bit recently. While no one, of course, knows exactly what the Fed would do, the possibility of adopting NIRP is certainly making our own internal discussions quite interesting.  

Monty J. Bennett is founder, chairman and CEO of the Ashford Group of Cos.s with $6 billion in assets under management as well as a Global Advisory Council member of HOFTEL, a worldwide hotel ownership group.