Do Negative Rates Have Positive Effects?


It appears that the new trend between central banks across the globe is negative interest rates. Major central banks such as the European Central Bank, Denmark’s Central Bank, Bank of Japan , and the National Bank of Switzerland. In fact, the first bank to welcome negative rates is the National Bank of Switzerland back in 2009 in efforts to support the Swiss economy against the global financial crisis. Since then, most central banks started easing their rates close to zero. The Eurozone’s central bank then followed and introduced negative rates six years ago in June 2014. Christine Lagarde’s predecessor, Former ECB Head Mario Draghi then announced the negative rates, -0.1%, to help stimulate the bloc’s economy. Just recently, the Bank of Japan announced that it will leave its interest rates unmoved, letting it sit in negative regions in the first month of 2020. The Japanese central bank adopted negative rates back in January 2016. It has aimed to prevent an unwanted surge in the yen’s strength. Because if unwelcome strength kicks in, the export-reliant economy of the country will be greatly affected. Now, US President Donald Trump himself is ramping up calls for the US Federal Reserve to ease their interest rates to negative. Which, in fact, comes in contrast to what his chief economic advisor, Larry Kudlow, advises. So, What’s With Negative Rates and Why Are Banks Adjusting their Monetary Policies Lower? For starters, they are commonly assumed by many to be the price that is paid whenever one borrows money. A simple example of this is if a bank holds its official interest rates at 5% and a borrower acquires a $200 loan, the borrower then will need to pay the initial amount plus $10 more. Meanwhile, if the bank sets its rates at -5%, the bank will be the one paying the borrower $10 once they repay it. Looking at it, means of negative ones to support the economy through encouraging business people and firms to loan is good. However, some policymakers and critics disagree and find it difficult to comprehend why a lender would actually be willing the pay people. Still, there are “unavoidable” and “inconceivable” reasons for a central bank to end up easing their rates to negative. Other central banks turn to this option as they scramble to come up with measures to support the economy. But Is It Good Though? Well, in theory, yes. Negative interest rates would hypothetically help stimulate the economy and help stave off inflation growth. But on the downside, it could have serious consequences or backfire on the economy. Thus, policymakers remain very cautious still. See, banks have certain assets such as mortgages, a debt instrument secured by collaterals of specific real estate properties. And mortgages are tied to interest rates by contract. So, such negative interest rates could squeeze the profit margins down to the point where the central banks would become more willing to lend less. Aside from that, in theory, again, there is nothing stopping deposit holders from withdrawing the funds and just stuffing the actual cash on their safe boxes. That would initially threaten banks to run out of cash from their systems. That would then, in turn, backfire and lead rates upward again. That is the exact opposite of what the negative rates were supposed to do in the first place. As paradoxical or absurd as this concept appears, other central banks are still settling to the negative rates. But that doesn’t mean that banks will stay below zero forever, after five long years of negative rates, Sweden’s central bank raised its interest rates from negative to zero (0) in December 2019. Riksbank was the first bank to resurface from negative rates. Stirring discussions whether other central banks, including the European Central Bank, should raise their interest rates.

Related Post