What Are “negative” Interest Rates and What They Mean for the Global Economy
What if bank interest rates were so low that they actually charged you a fee to keep your money there? What if you could take out a loan with no interest at all? This is the idea of negative interest rates. We’re kind of in uncharted territory with this concept, which is why it’s been making headlines lately. Here’s a rundown of what negative interest rates are and what to expect from them.
The goal of negative interest rates
In general, the purpose of negative interest rates is to encourage people to spend more, save less, and borrow.
When the economy is stagnating and people are not spending, the country’s central bank (like the US Federal Reserve ) lowers interest rates to stimulate spending. Ideally, people are more willing to take out loans and mortgages at low interest rates, so they pump money into the economy. They are also less likely to save money because there is no incentive to do so.
The point is that central banks around the world have already lowered their interest rates to zero, and this is not enough; their economies are still in stagnation. Their solution? Negative interest rates.
Japan cut interest rates to -0.1 percent in February, and recently the European Central Bank cut them to -0.4 percent. The five central banks of the world – the European Central Bank ,Bank of Japan , National Bank of Denmark, National Bank of Switzerland and Riksbank of Sweden – have negative interest rates. According to Investopedia, when the economy goes into negative territory, the following happens:
A negative interest rate means that the central bank and possibly private banks will charge negative interest: instead of receiving money on deposits, depositors must pay regularly to keep their money in the bank. This is done to encourage banks to lend money more freely, and businesses and individuals to invest, lend and spend money, rather than pay a commission for their safety.
In short, banks are now required to hold funds, and some of them may pass these costs on to customers. According to the BBC , this is already happening in some cases, mostly with large balance sheet companies. At least consumers don’t make a dime by saving money in their bank accounts. On the other hand, in theory, people can borrow free of charge. The New York Times writes about it this way :
The longer it takes to pay off your negative interest rate mortgage, the less you owe, even if you pay nothing. In short, negative rates can make saving money stupid, while borrowing can become incredibly attractive.
Overall, lowering interest rates to negative levels is a rather unorthodox move. We’re not sure what will happen, but there are obviously some concerns.
What does this mean for banks
One of the biggest problems is the “mattress effect”: bank customers withdraw cash and put it under a shaped mattress. What’s the point of keeping it in a zero interest savings account? If everyone takes their money, the banks won’t have to lend. http://fortune.com/2016/02/23/jap…
In addition, banks make money by charging interest on loans. If the rates are zero, they earn nothing. Contrast this problem with not having a lot of money to lend, and there is a fear that negative interest rates will ultimately ruin the banks. And we don’t want banks to go bankrupt , because that usually seriously ruins the economy.
However, as CNBC points out , it’s not all that bleak. Central banks are aware of these dangers and are working to minimize them:
For example, the Bank of Japan’s negative interest rate policy applies only to 10 percent of commercial banks’ reserves at the central bank, with most of the reserves at zero or marginally positive interest rates. This “tiered” system is designed to limit the impact of negative interest rates on banks’ bottom line. The ECB, which many expect to ease its monetary policy further in March, may be considering a similar approach …
They point to Switzerland and Sweden as evidence that negative interest rates can be good. Bank lending in these countries is growing faster than in the eurozone, although rates are much lower, according to CNBC.
Negative US interest rates
While Federal Reserve Chairman Janet Yellen said negative interest rates could be on the table , we probably won’t get there anytime soon. First, the Fed recently raised interest rates . Also, a lot has to go wrong before we start considering negative interest rates, and so far, our economy is okay. Forbes explains :
… while the stock and commodity markets have been volatile and painful lately, the US economy isn’t all that bad. The basic labor market has shown sustained resilience and consumption resilient. Consequently, the US is far from needing another big round of monetary policy easing, especially in the form of negative interest rates.
It’s too early to tell if negative interest rates are working for other economies. In general, economists seem to be ripped at them: some say this is a terrible idea, others say that they are already working . For now, only time will tell.