BEING NEGATIVE

Sifat Kaur Cheema

Explaining the surprising negative interest rates in few Economies.

Negative interest rates are when instead of receiving interest income you incur a charge for the cash deposits. Depositors must pay regularly to keep their money with the bank. A negative interest rate policy (NIRP) is an unusual monetary policy tool in which financial institutions are required to pay interest for parking excess reserves with the central bank on any surplus cash beyond that which regulators say ask them to keep on hand. That way, central banks penalize financial institutions for holding on to cash in the hope of encouraging them to boost lending to businesses and consumers to stimulate aggregate demand and production of goods and services. In addition, negative interest rates would also discourage capital inflow from abroad and encourage capital outflow, thereby depreciating domestic currency and boosting net exports for the domestic country.

As crazy as the negative interest rates sound, the policy was first introduced by the central bank of Denmark in 2012. In 2014, the European Central Bank lowered its deposit rate to -0.1%. This was done in order to battle with the global financial crisis triggered by the collapse of Lehman Brothers in 2008. The experiment was to in the hope that individuals and businesses would be encouraged to borrow more, increase spending, stimulate economic activity, and create jobs giving strength to economic growth. Then Japan followed with the negative interest rate experiment in 2016 mostly to prevent an unwelcome strengthening of the yen from hurting an export-reliant economy. What first seemed unorthodox has become habitual now. The era of negative rates is now the subject of a debate about whether the policy has distorted financial markets, crippled banks, and threatened pensions. Faced with renewed signs of economic weakness, the European Central Bank pushed its benchmark interest rate further below zero in September 2019, charging banks 0.5 percent to hold their cash. Sweden in July set a global record of minus 1.25%, Switzerland, Denmark and Japan have also stuck with rates in the red.

Because central bank rates provide a benchmark for all borrowing costs across an economy, the policy spilled over to negative interest rates across the financial system: on interbank deposits, the deposits of ordinary individuals, government bonds, and also the bonds of highly credit-worthy corporate borrowers. That means investors buying those securities won’t get all of their money back. They would start preferring to keep their savings in cash. By mid-2019, the pile of negative-yielding bonds topped $17 trillion, or a quarter of all investment-grade debt, increasing the focus on how citizens would be hurt when their retirement savings fail to grow. 

U.S. President Donald Trump has complained that the Federal Reserve has avoided negative rates. The disparity in rates between the U.S. and much of the rest of the world has drawn investment toward dollar-denominated assets, driving the value of the currency up and potentially hurting U.S. exports. If more and more Central banks would start using the negative interest rate policy it ultimately might lead to a war of competitive devaluations and not inclusive growth for all. There’s also a growing fear about its impact on savers and concern about how that could blot the public’s view of the central bank. 

The Economies that have cut interest rates below to zero have not experienced major growth but might have probably prevented worse deflationary pressures. There are limits to how far interest rates can fall below zero and the Central Banks have hesitated to cut interest rates further into negative territory in fear of the harmful economic side effect. The impact of depleting saving rates and increasing household debt will be most felt in the near future. Time would only tell about the impact of these negative interest rates.