What are negative interest rates?
This is a question that you may have heard recently. As global economies are slowing, central banks have become increasingly willing to consider unorthodox economic policies, including the use of negative-interest-rate policies.
Negative interest rates are a type of monetary policy used to stimulate economic activity. This is accomplished by setting a target interest rate below the inflation rate and encouraging financial institutions to borrow money from the central bank in order to stimulate lending.
At its simplest, a negative interest rate policy means that a central bank would charge financial institutions to keep excess funds at the central bank. This creates a disincentive for companies to park assets with their bank rather than investing in the real economy.
In this article we’ll explore what negative interest rates are, how they differ from traditional monetary policy, and their potential implications.
What Are Negative Interest Rates?
Negative interest rates refer to a situation where the central bank sets a target interest rate below the inflation rate and encourages financial institutions to borrow money from its balance sheet. This is in opposition to the traditional interest rate target of 0% or higher, which incentivizes companies to keep assets at their bank rather than investing in the real economy.
Negative interest rates create a situation where companies may have to pay the central bank to hold their excess balance sheet reserves. Banks, in turn, pass on these costs to consumers and businesses, resulting in higher borrowing costs. The hope is that higher borrowing costs will make companies and individuals more likely to invest in capital projects, create jobs and make other purchases, thus aiding economic growth.
Ultimately, the goal of negative interest rate policy is to stimulate economic activity by incentivizing companies to invest and hire.
History of Negative Interest Rate Policy
Negative interest rate policies were first considered by the Japanese central bank in the late 1990s as they attempted to encourage economic growth during a period of deflation. Since then, the European Central Bank, the Swiss National Bank and other central banks have adopted negative interest rate policies in response to slow global economic activity.
In January of 2015, the European Central Bank (ECB) adopted a negative interest rate policy targeting a benchmark rate of -0.1%. This was the first time a major central bank had instituted a negative interest rate policy. Since then, the ECB has continued pushing rates further and further downward.
Advantages and Disadvantages of Negative Interest Rates
Negative interest rates offer a number of potential advantages for economies struggling with low inflation and slow economic growth. Lower borrowing costs can spur investment, job and wages growth. It can also help ensure that the prices of goods and services remain stable by keeping borrowing costs low.
At the same time, there are some potential risks associated with negative interest rates. Many banks are reluctant to pass on the cost of negative interest rates to customers and as a result, may choose to restrict lending and thus reduce the efficacy of the policy.
Additionally, negative interest rates could also incentivize companies and individuals to save more, which could reduce the efficacy of the policy. This is because savings tend to reduce potential income, which could lead to declining economic activity. Additionally, there is no guarantee that a negative interest rate policy will lead to economic growth and there is a risk that it could further damage economic activity if it is not employed carefully.
How Do We Measure Negative Interest Rates?
Negative interest rates are measured using a number of different metrics. Generally, a negative interest rate is measured as a percentage or a point below a certain rate of inflation. The most common metric for measuring negative interest rates is the real interest rate, which is calculated by subtracting the prevailing inflation rate from the nominal interest rate.
For example, if inflation is 1%, and the nominal interest rate is 0%, then the real interest rate is -1%. This indicates that the central bank has set a target interest rate below the inflation rate.
Implications of Negative Interest Rates
Negative interest rates have a number of implications for the global economy. For one, they could potentially improve the efficiency of the global economy by providing cheaper capital to companies and individuals.
Furthermore, they could also lead to a weaker U.S. dollar and a stronger euro, as investors shift their focus away from U.S. government debt. Additionally, it could lead to an increase in aggregate demand in the global economy, as companies and individuals use the cheaper capital to invest in capital projects and other activities.
Negative interest rates are a type of unorthodox monetary policy that central banks have increasingly been turning to in response to slow economic activity. This type of monetary policy involves the central bank setting a target interest rate below the inflation rate, encouraging financial institutions to borrow from its balance sheet to stimulate lending.
Negative interest rates are largely seen as a tool to stimulate economic activity by making it cheaper for companies and individuals to access capital. While there are a number of potential benefits associated with negative interest rates, there are also a number of potential risks associated with this type of policy. Ultimately, the success of a negative interest rate policy is largely dependent on how it is employed.
