How Low Can Interest Rates Go in China and the West?


The overwhelming majority of economists (yours truly included) who recommended preparing for the next financial/economic calamity in the aftermath of the Great Recession (I for one have even written a Wall Street Journal and USA Today best-selling book on the topic back in 2018, The Age of Anomaly) have suspected to the point of being close to certain that when disaster strikes again, governments and central bank will resort to… well, more of the same, in other words lower interest rates and stimulus.

This is, to pretty much nobody’s surprise, precisely what happened.

What was more than surprising, however, was the fact that few economists would have expected central banks as well as governments to be this aggressive, this coordinated and this quick to throw the proverbial kitchen sink at the problem. The Federal Reserve for example almost immediately cut interest rates by 50 basis points and then shortly thereafter brought them all the way back to zero again, with them also providing trillions in the way of financial system liquidity as well as a wide range of other solutions. Other central banks followed suit, with governments also putting their foot firmly on the pedal with respect to the fiscal stimulus dimension.

When it came to Keynesian economists, they have continuously criticized various administrations from all around the world for not being aggressive enough. In other words, for now lowering interest rates enough, for not being aggressive enough when providing liquidity (which led to a lot of it essentially being “hoarded” as banking system reserves), for under-performing on the fiscal stimulus front compared to the monetary stimulus one and so on.

Today’s situation should therefore be considered the ultimate let’s call it aggressive Keynesianism test. While there are most definitely Keynesian economists who are more reserved when talking about how low interest rates can actually go, other colleagues tend to be aggressive to the point of explaining that there is absolutely nothing to worry about because central banks still have plenty of ammunition left in this respect.

Are the latter economists correct?

As always, nobody knows because answering the question above would involve predicting the future, something human beings tend to be remarkably terrible at. Therefore, time will ultimately tell. What we can and in our opinion should do, however, is try to tackle this issue from a let’s call it game theory perspective by putting ourselves in the position of perhaps the most neglected to the point of pretty much hated (or so it seems) category of citizens: savers.

Even well before the 2020 developments, interest rates were low almost everywhere and, indeed, there have been economists who were concerned right from the beginning of the Great Recession response days that excessively low interest rates might lead to the banking system facing massive capital flight. In other words, that the average depositor would not be willing to accept letting the bank handle his money in exchange for a paltry interest rates and as such, demand cash. Needless to say, if that would have occurred at scale, the banking system as we know it would have collapsed due to the fractional reserve nature of it.

Fortunately, as we now know, it… well, didn’t.


For the most part because the average depositor is complacent. No, nobody likes receiving nothing in return as a depositor but as the joke goes, people are more likely to change their wives than their bank and as such, the overwhelming majority of depositors remained passive. The same principle is valid when it comes to negative interest rates because, and therein lies the nuance worth highlighting, they are only MARGINALLY negative. In other words, even “worst case scenario” depositors who are essentially forced to pay the bank to keep their money are only in marginally negative interest rate territory and therefore, for reasons which mostly revolve around a combination between being complacent and being scared of keeping too much money literally under the mattress, depositors didn’t exactly demand their money in cash form en masse.

However… game theory time.

We have already established that with interest rates at zero or even slightly negative (let’s say -0.1%), nobody is panicking.

What if they were lowered to -0.5%?

More likely than not, additional depositors would complain but a panic significant enough to bring about a bank run is hardly probable.

What about -1%?

In that case, let’s say (for the sake of our little thought process) that 5% of depositors would finally decide that enough is enough and ask for their money.


Maybe 8% would decide to leave in the scenario in question, once again for the sake of our example… a percentage which would give bank managers jitters but not enough, at that point in time, to turn banks into essentially insolvent entities.


This is where things get tricky because if 10% or more of depositors decide to leave the banking system, the equation stops working. Reserve requirements differ from jurisdiction to jurisdiction but all in all, the message should be crystal clear: as of a certain point, sooner rather than later, the percentage of depositors who decide they have had it becomes significant enough so as to put serious strain on the banking system.

The tolerance in question differs from country to country. In China and let’s say non-Western economies where inflation rates are higher than in the US or EU nations, depositors would definitely be far less likely to tolerate negative interest rates because aside from the rates in question, they would be “punished” by inflation as well. Again, it depends but as a bit of a conclusion, the team wants to make it crystal clear that yes, there is a limit as to how low central banks can go interest rate-wise and while that limit differs on a country to country basis, it isn’t that significant of a stretch to state that it might be wise to assume the tipping point in question is quite close. Wouldn’t it therefore be wise to act accordingly by no longer assuming that central banks have economic “super powers” that enable them to defy the limits of game theory and ultimately common sense?