{"id":10939,"date":"2020-05-21T04:17:06","date_gmt":"2020-05-21T04:17:06","guid":{"rendered":"http:\/\/emilynews.com\/blog\/?p=10939"},"modified":"2020-05-21T04:17:07","modified_gmt":"2020-05-21T04:17:07","slug":"news-commentary-1064-negative-interest-rates","status":"publish","type":"post","link":"https:\/\/emilynews.com\/blog\/?p=10939","title":{"rendered":"News Commentary #1,064 – Negative Interest Rates"},"content":{"rendered":"\n

Get Paid to Borrow!<\/strong><\/p>\n\n\n\n

There are a number of European banks that are now charging \u201cnegative\u201d interest rates.  Sounds confusing, right?  It boils down to a bank PAYING you to borrow money and CHARGING you to save it.  And, that\u2019s enough to twist your head into knots.  In an effort to understand all this better, I did a little bit of research and found the following article in Investopedia<\/em>.  It\u2019s very informative and worth reading<\/p>\n\n\n\n

How Negative Interest Rates Work<\/strong><\/p>

By\u00a0MATTHEW JOHNSTON<\/p>

Interest rates\u00a0are often defined as the price paid to borrow money. For example, an annualized 2% interest rate on a $100 loan means that the borrower must repay the initial loan amount plus an additional $2 after one full year. So what does it mean when we have a negative\u00a0interest rate\u2014meaning borrowers are credited interest, instead of being charged it? That, say, a -2% interest rate means the bank pays the borrower $2 after a year of using the $100 loan?<\/p>

At first glance,\u00a0negative interest rates\u00a0seem like a counterintuitive, if not downright crazy, strategy. Why would a lender be willing to pay someone to borrow money, considering the lender is the one taking the risk of loan\u00a0default? Inside-out as it might appear, though, there are times when central banks run out of policy options to stimulate their nations’ economy and turn to the desperate measure of negative interest rates.<\/p>

KEY TAKEAWAYS<\/p>

Negative interest rates are an unconventional, and seemingly counterintuitive, monetary policy tool. Central banks impose the drastic measure of negative interest rates when they fear their national economies are slipping into a deflationary spiral, in which there is no spending\u2014and hence, dropping prices, no profits, and no growth. With negative interest rates, cash deposited at a bank yields a storage charge, rather than the opportunity to earn interest income; the idea is to incentivize loaning and spending, rather than saving and hoarding. In recent years, several European and Asian central banks have imposed negative interest rates on commercial banks.<\/p>

Negative Interest Rates in Theory and Practice<\/p>

Negative interest rates are not only an unconventional monetary policy tool, but they are also a recent one. Sweden’s central bank was the first to deploy them: In July 2009, the Riksbank\u00a0cut its overnight deposit rate to -0.25%\u00a01<\/sup>\u00a0The European Central Bank (ECB)\u00a0followed suit in June 2014\u00a0when it lowered its deposit rate to -0.1%.2<\/sup> Other European countries and Japan have since opted to offer negative interest rates, resulting in $9.5\u00a0trillion worth of government debt carrying negative yields in 2017.3<\/sup><\/p>

Why did they take this drastic measure? The monetary policymakers were afraid that Europe was at risk of falling into a\u00a0deflationary spiral. In\u00a0harsh economic times, people and businesses tend\u00a0to hold on to their cash while they wait for the economy to improve. But this behavior can\u00a0weaken the economy further, as a\u00a0lack of spending causes further job losses,\u00a0lowers profits, and prices to drop\u2014all of which reinforces\u00a0people\u2019s fears, giving them even more incentive to hoard. As spending slows even more, prices drop again, creating another incentive for people to wait as\u00a0prices fall further. And so on.<\/p>

This is precisely the deflationary spiral that European central banks are trying to avoid with the negative-interest strategy, which not only affects bank loans but bank deposits.<\/p>

When you deposit money in an account at a financial institution, you are in effect becoming a lender\u2014letting the bank have use of your funds\u2014and the institution effectively becomes a borrower.<\/p>

With negative interest rates, cash deposited at a bank yields a storage charge, rather than the opportunity to earn interest income. By charging European banks to store their reserves at the central bank, the policyholders hope to encourage banks to lend more.<\/p>

In theory, banks would rather lend money to borrowers and earn at least some\u00a0interest as opposed to being charged to hold their money at a\u00a0central bank. Additionally, negative rates charged by a central bank may carry over to deposit accounts and loans. This means\u00a0that deposit holders would also be charged for parking their money at their local bank while some borrowers enjoy the privilege of actually earning money by taking out a loan.<\/p>

Another primary reason the ECB has turned to negative interest rates is to lower the value of the\u00a0euro. Low or negative yields on European debt will deter foreign investors, thus weakening demand for the euro. While this decreases the supply of financial capital, Europe’s problem is not one of\u00a0supply but of\u00a0demand. A weaker euro should stimulate demand for exports and,\u00a0hopefully, encourage\u00a0businesses to expand.<\/p>

Risks of Negative Interest Rates<\/p>

In theory, negative interest rates should help to stimulate economic activity and stave off inflation, but policymakers remain cautious because there are several ways such a policy could backfire. Because banks have certain assets such as\u00a0mortgages\u00a0that are contractually tied to the prevailing interest rate, such negative rates could\u00a0squeeze\u00a0profit margins to the point where banks are actually willing to lend less.<\/p>

There is also nothing to stop deposit holders from withdrawing their money and stuffing the physical cash in mattresses. While the initial threat would be a run on banks, the drain of cash from the banking system could lead to a rise in interest rates\u2014the exact opposite of what negative interest rates are supposed to achieve.<\/p>

Although the Federal Reserve, the U.S. central bank, has never imposed negative interest rates, it has come close with near-zero rates\u2014most recently on Mar. 15, 2020, when it cut the benchmark interest rate to a 0%-.25% range.<\/em><\/p>

The Bottom Line<\/p>

While negative interest rates may seem paradoxical, this apparent intuition has not prevented\u00a0a number of European and Asian central banks from adopting\u00a0them. This is\u00a0evidence of the dire situation that policymakers believe is characteristic of the European economy. When the\u00a0Eurozone\u00a0inflation rate dropped into deflationary territory at -0.6% in Feb. 2015, European policymakers promised to do whatever it took\u00a0to avoid a deflationary spiral. However,\u00a0even as Europe entered\u00a0unchartered monetary territory, a number of analysts warned\u00a0that\u00a0negative interest rate policies could have severe unintended consequences.<\/p><\/blockquote>\n\n\n

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Get Paid to Borrow! There are a number of European banks that are now charging \u201cnegative\u201d interest rates.  Sounds confusing, right?  It boils down to a bank PAYING you to borrow money and CHARGING you … News Commentary #1,064 – Negative Interest Rates<\/span>Read more<\/a><\/p>\n","protected":false},"author":1,"featured_media":9422,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6],"tags":[4215,4212,4214,3656,4004,4216,4217,4213,4211],"class_list":["post-10939","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-information","tag-bank-paying","tag-bitcoin-price","tag-borrow-money","tag-btc-news","tag-btc-update","tag-crypto-bank","tag-crypto-era","tag-european-banks","tag-negative-interest-rates","exalt-entry"],"yoast_head":"\nNews Commentary #1,064 - Negative Interest Rates - EmilyNews<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/emilynews.com\/blog\/?p=10939\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"News Commentary #1,064 - Negative Interest Rates - EmilyNews\" \/>\n<meta property=\"og:description\" content=\"Get Paid to Borrow! 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