What Are Negative Interest Rates?

What Are Negative Interest Rates?

By P.B. Bachman
ECB460
What is the least you could earn by depositing money somewhere? Conventional logic would say, “You could earn as little as nothing.” When the term “interest rate” comes to mind, we assume a positive number. For example, an interest rate of 4% looks and sounds natural to us. We either pay that amount on money we owe someone, or we earn that amount by lending money to someone else.

It is unusual to think of an interest rate with a negative sign in front of it. An interest rate of -0.5% seems odd at first glance. Negative interest rates have been in the news a lot recently. What is a negative interest rate anyway?

Some central banks have begun implementing negative interest rate policies in recent years, including as recently as this month in Japan. Historically, negative rates have not been in the realm of possibility. But after lowering rates all the way to zero after the 2008 financial crisis to spur economic recovery, some central banks continued the train of thought by actually dipping rates below zero.

Five central banks (Denmark, the Eurozone, Sweden, Switzerland, and Japan) currently have negative rates. For example, the European Central Bank has a -0.3% deposit rate for banks. Instead of banks earning interest on their reserves held at the ECB, banks instead are charged for keeping their funds at the ECB.

Central banks enact monetary easing like this to attempt to incentivize their nations’ banks to loan money. Central banks reckon that banks making loans helps to stimulate the economy as consumers spend and invest. The central banks’ goal is to raise inflation to around 2%.

The effectiveness of negative rates has yet to prove itself in the long run. Some economists see some success in Europe through decreasing the value of European currencies, which helps European exporters. There are side effects as well, and it does not help savers. Although this has not happened yet in most cases, it is possible that retail banking customers could be penalized for having money in the bank if banks pass along negative rates.

The Federal Reserve appears to be acting contrary to other major central banks, having pushed rates up instead of down at its meeting in December. However, Federal Reserve chair Janet Yellen said on February 11, 2016 that the idea of negative rates is not “off the table.” She stressed that such a move is not imminent and would only be considered in the face of much worse economic conditions.

We will wait to see if the broadly-unpopular negative rates come to the US. Until then, we can at least try to appreciate a bank account earning 0.05%.

Comments are closed.

Form ADV Part 2A

Form CRS