John Maynard Keynes said, “When my information changes I alter my conclusions. What do you do, sir?” For Keynesians and non-Keynesians alike, it is excellent advice — essential, in fact — and it applies in spades to the mounting confusion about negative interest rates.
One major point on which Keynes eventually would have had to change his mind was his 1936 comment, long uncontroversial, that “the rate of interest is never negative.” By February 2016, one-year government bond yields in 12 out of 15 developed countries were negative. Even fiveyear bond yields were negative in the majority of these countries. [See Figure I.]
The idea that $1,000 to be received a year from now could be worth more than $1,000 in the bag today is counter to common intuition. A present dollar has a different value than a future dollar. When inflation is sufficiently high, a future dollar is almost worthless. But by the same logic, when prices are consistently falling, a future dollar could be more valuable than a present dollar.
Negative Rates — Natural and Unnatural. Ignoring central-bank interference for a moment, the higher the sustained rate of inflation, the higher the interest rate that will accompany it. Symmetrically, negative interest rates should be associated with negative inflation (deflation). Negative inflation is unusual and has almost never been sustained for long periods of time. That explains why episodes of negative interest rates are so rare, and why their potential existence was unrecognized for so long. Although Keynes did not live to see it, interest rates ought to be negative at a sufficiently high rate of price level decline.