After the Great Recession, quantitative easing, a housing market meltdown, Lehman Brother’s shutting down and numerous other dramatic economic events over the past several years, what could possibly be next? Have we seen it all? Well maybe not yet. Negative interest rates, you say? After some of the most tumultuous global economic turmoil the world has ever experienced, there is talk (and actual implementation globally) of negative rates of interest.
What are negative interest rates? Definitively speaking: A negative interest rate policy is an unconventional monetary policy tool whereby nominal target interest rates are set with a negative value, below the theoretical lower bound of zero percent. Real-world speaking: Imagine depositing $1,000 in your bank account for a year and receiving $97 in 365 days. That doesn’t sound fair to me, and it isn’t for savers.
However, global economic growth has been so anemic over the past several years that negative interest rates have become reality in several countries across the world……..central banks in Japan, Europe, Switzerland, Sweden, Hungary and Denmark have been initiating this unorthodox policy. For example, the European Central Bank is now charging banks 0.4% to hold their money. Switzerland and Denmark have pushed their key rates to -0.75% and Sweden to -0.85%. In the sovereign bond market, roughly 16% if the world’s government bonds are already paying negative yields.
The idea behind negative interest is almost a last-chance effort to stimulate an economy. Instead of banks paying ultra-low interest to savers, the idea behind negative interest rates is for those same savers to spend that money in the economy – for example, through buying goods or using the funds to start a business. Furthermore, negative rates of interest would reduce the cost of money for households and corporations, making loans easier to get, which in theory would jump-start an economy even further. A third rationale for negative interest rates is to keep the value of a country’s currency weak in order to stimulate export activity. Here, low (or even negative) rates deter investors from exchanging their currency into the foreign currency.
As far as the US is concerned, a negative interest policy has not been adopted or even seriously considered, but Fed chairwoman Janet Yellen said she would “leave the door open for negative interest policy”. We’ll see what develops.
The attached video from the Wall Street Journal, “Negative Interest Rates: How Do They Work?” is a great little clip that summarizes negative interest rate policy.