What 'Negative' Interest Rates Are, And What They Mean For Global Economies

What

What if a bank's interest rates were so low, they actually charged you to keep your money there? And what if you could take out a loan without paying any interest at all? That's the idea behind negative interest rates. We're sort of in uncharted territory with this concept, which is why it's making headlines lately. Here's a quick rundown of what negative interest rates are and what we can expect from them. Illustration: Fruzsina Kuhári.

The Goal of Negative Interest Rates

In general, the goal of negative interest rates is to encourage people to spend more, save less, and take out loans.

When the economy stagnates and people aren't spending money, a country's central bank (like the Federal Reserve in the United States or the Reserve Bank of Australia) lowers interest rates to encourage spending. Ideally, people are more willing to take out loans and mortgages when rates are low, so they pump money into the economy. They're also less likely to save since there's no incentive to do so.

The thing is, central banks around the world have already lowered their interest rates to zero, and it's not doing enough; their economies are still pretty stagnant. Their solution? Negative interest rates.

Japan lowered interest rates to -0.1 per cent in February, and recently, the European Central Bank lowered them to -0.4 per cent. Five of the world's central banks — the European Central Bank, the Bank of Japan, Denmark's National Bank, the Swiss National Bank and Sweden's Riksbank — all have negative interest rates. When economies venture into negative territory, here's what happens, according to Investopedia:

A negative interest rate means the central bank and perhaps private banks will charge negative interest: instead of receiving money on deposits, depositors must pay regularly to keep their money with the bank. This is intended to incentivise banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe.

In short, banks are now being charged to hold funds, and some of them might pass this expense onto customers. According to the BBC, this is already happening in some cases, mostly to businesses with large balances. At the very least, consumers aren't earning a dime for saving money in their bank accounts. On the flip side, though, people can theoretically take out loans for free. The New York Times puts it this way:

The longer it takes to repay a negative-interest-rate mortgage, the less you owe, even if you pay nothing. In short, negative rates can make saving money seem foolish, while borrowing can become epically attractive.

In general, pushing interest rates into the negative is a pretty unorthodox move. We're not sure what will happen, but obviously, there are some concerns.

What It Means for Banks

One of the biggest concerns is the "mattress effect": bank customers will withdraw their cash and stuff it under a figurative mattress. What's the point in keeping it in a savings account with zero interest? If everyone withdraws their money, banks won't have any to lend.

Plus, banks make money by charging interest on loans. If rates are at zero, they're not making any money. Pair that problem with not having much money to lend in the first place, and there's the fear that negative interest rates will eventually ruin banks. And we don't want banks to fail, because that usually royally screws up the economy.

As CNBC points out, though, it's not nearly that grim. Central banks know these dangers and work to minimise them:

For example, the BoJ's negative interest rate policy applies to only about 10 per cent of commercial bank reserves at the central bank, with the majority of reserves attracting a zero or marginally positive interest rate. This "tiered" system is designed to limit the impact of negative interest rates on banks' bottom line. The ECB, widely expected to ease its monetary policy stance further in March, may be thinking of adopting a similar approach…

They point to Switzerland and Sweden as evidence that negative interest rates might be a good thing. According to CNBC, bank lending in those countries is growing faster than the Eurozone, even though rates are much lower.

Negative Interest Rates in the US and Australia

Even though the Federal Reserve chair, Janet Yellen, has said that negative interest rates might be "on the table," chances are the US won't get there any time soon. For one, the Fed just raised interest rates recently. Plus, a lot has to go wrong before they start considering negative interest rates, and for now, their economy is doing OK. Forbes explains:

...while the stock and commodities markets have been volatile and painful of late, the U.S. economy is just not that bad off. The underlying labour market has shown continued strength and consumption has been resilient. Consequently, the U.S. is far from needing another big round of monetary policy easing, especially in the form of negative interest rates.

Similarly, Australia isn't in a position where negative interest rates are likely to be implemented. However, senior economist with Deutsche Bank Phil O'Donoghue told the ABC that negative interest rates in other countries may cause the Australian dollar to move higher.

It's too early to know whether or not negative interest rates are working for other economies. In general, economists seem torn on them — some say they're a terrible idea, others say they're already working. At this point, only time will tell.


Comments

    very interesting article. thanks for the well explained reading. normally this type of stuff goes way over my head.

    I've always looked at the relationship between Central banks and interests like a gambler in a casino. Doing it every now and then and knowing when to step back can net you a positive impact; however when you start losing and decide you want to double down you walk away with nothing.

    Negative interest rates is the central bank equivalent of saying "we let the economy get fucked on our watch but we don't want to admit it so lets experiment instead. After all if it blows up it'll just be the average people that suffer; and they're going to be mad at us regardless"

    Edit: Additionally worth noting that interest rates only impact an economy when the population actually has a level of spending left to utilize; if they're already pressed for cash lowering interest rates or making them negative does absolutely nothing except create a highly leveraged and risk flooded financial system.

    Last edited 17/03/16 11:13 am

    Excellent informative article. This will make a difference to my life choices. Way to fulfil your name Lifehacker.

    Interesting. So as an Australian citizen wanting to purchase property in Australia, is there a legal way to get my mortgage from a nation with a negative interest rate?

      A bank will be very unlikely to loan money against an asset in a different country, so the short answer is: No. Not really.

      It's not about legality, it's about them protecting themselves if you default on your mortgage.

    Woah, woah, woah. I applaud the effort to tackle the subject but I disagree with some of the assessments and I fear it paints a somewhat blurred picture of reality.

    It's a struggle to explain something without keeping it in a vacuum or complicating it with the rest of the world. Unfortunately this is too much in a vacuum. You have to at least explain the role inflation (or rather deflation) plays in both the policy making and effect.

    Sorry to say this but where are the usual economics professors that write here? For one I'd be interested to see their views on why the traditional interest rate transmission isn't working.

    Also the question about borrowing from overseas with lower rates. I don't know about Australia but it happens in other countries for small businesses and property. In any case the exchange rate risk needs to be taken into account. I know someone in another country that borrowed with very low interest yen only for its value to dramatically increase and wipe out his company even though the rate itself didn't change. There's currency hedging, sure. But then it makes things expensive anyway.

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