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What are Negative Interest Rates?

2016-09-24T15:34:45+00:00

The term 'Negative Interest Rates' is included in the Economics edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Negative interest rates are those that fall below 0%. In the past, negative interest proved to be only a theoretical discussion that economists played around with for the sake of argument. In 2010 Sweden’s central bank put these rates into practice as a means of stemming the flow of outside money into the country. Denmark followed suite in 2012. Since then, minor to major central banks have moved into the mostly uncharted waters of these negative rates.

The reason that central banks would be interested in such negative interest rates is that they help the economy. Central banks cutting the rates into negative territory creates a similar effect as simply lowering interest rates. Lower rates help consumers to spend and businesses to invest more.

They also boost prices in the stock markets and other risk assets. They reduce the level of the nation’s currency. This helps exports to be more competitive against other country’s goods. Finally lower rates cause people to expect higher inflation rates in the future. This encourages consumers to spend their money now as opposed to later when it will be worth less.

The world has many decades of knowledge of what happens when central banks influence economies by reducing rates from 3% to 2% because of downturns in the economy. In theory this shifting to negative interest rates is similar with the difference of a starting point at or below zero.

Such NIRP negative interest rate policies are called unconventional monetary tools. The idea is to move benchmark interest rates into negative territory. Doing so means breaking the centuries’ long barrier of 0%.

Deflation is what caused desperate central banks to pursue these negative interest rates and policies. In times where deflation pervades an economy, the businesses and consumers tend to hold their money rather than invest and spend it. Eventually this creates a reduction in total demand that in turn causes prices to fall even more. Output and production slow down and unemployment increases as a result.

Stagnation like this is typically avoided when central banks pursue a loose monetary policy. The problem arises when the deflation becomes so powerful that dropping interest rates to zero is no longer enough to encourage lending and borrowing.

The result of negative interest rates is profound. Central banks charge their commercial banks money (negative interest) in order to keep their deposits at the bank. Commercial banks then pass along these costs to their larger account holders as they are able. The financial institutions have not much stooped to official negative rates on their depositors. Instead they charge fees for keeping money in these current accounts. This amounts to negative rates under the guise of a different name.

Central banks hope that the commercial banks will loan out money instead of paying to hold it. Instead many banks have been paying the fees themselves, and this has impacted bank profits. Banks fear passing along fees to small deposit account holders who may withdraw their money instead.

As of 2016, the negative interest rate policy has been adopted by the European Central Bank, the Swiss National Bank, and the Bank of Japan besides the Scandinavian Central Banks. Early evidence suggests that the Euro zone did manage to reduce interbank loans with the negative interest rates. Companies have not so far much benefited from the negative interest rates. This is because the risk is perceived to be higher with corporations who borrow than with governments. One notable exception is with Nestle the Swiss food conglomerate that has issued negative interest rate corporate bonds.

The term 'Negative Interest Rates' is included in the Economics edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.