How Negative Interest Rates Work ?

The United States has never used negative interest rates, though that may change. In September of 2019, President Trump suggested the Federal Reserve implement them. Negative interest rates are not unheard of as Europe and Japan are using them in the hope of jump-starting economic growth. Any nation that is forced to use negative interest rates is living far beyond their means. This may help delay the inevitable, but at some point in the near future, we are all going to have to deal with the fact that there is going to be a severe and prolonged economic correction. Be prepared. Welcome to The Atlantis Report . To battle the global financial crisis triggered by the collapse of Lehman Brothers in 2008, many central banks cut interest rates near zero. A decade later, interest rates remain low in most countries due to subdued economic growth. With little room to cut rates further, some major central banks have resorted to unconventional policy measures, including a negative rate policy. The euro area, Switzerland, Denmark, Sweden and Japan have allowed rates to fall to slightly below zero. So How Negative Interest Rates Work ? Negative interest rates refer to a scenario in which cash deposits incur a charge for storage at a bank, rather than receiving interest income. Instead of receiving money on deposits in the form of interest, depositors must pay regularly to keep their money with the bank. This environment is intended to incentivize banks to lend money more freely. Interest rates are typically assumed to be 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. On the other hand, a -2% interest rate means the bank pays the borrower $2 after a year of using the $100 loan, which is counterintuitive. While negative interest rates are a strong incentive to borrow, it is difficult to understand why a lender would be willing to provide funds considering the lender is the one taking the risk of a loan default. While seemingly inconceivable, there may be times when central banks run out of policy options to stimulate the economy and turn to the desperate measure of negative interest rates. Negative interest rates are an unconventional monetary policy tool. They were first deployed by Sweden's central bank in July 2009 when the bank cut its overnight deposit rate to -0.25%. The European Central Bank (ECB) followed in June 2014 when it lowered its deposit rate to -0.1%. Other European countries and Japan have since chosen negative interest rates resulting in $9.5 trillion worth of government debt carrying negative yields in 2017, according to Fitch. Negative interest rates are a drastic measure that shows that policymakers are afraid that Europe is at risk of falling into a deflationary spiral. In harsh economic times, people and businesses tend to hold on to their cash while they wait for the economy to improve. But this behavior can weaken the economy further, as a lack of spending causes further job losses, lowers profits, and reinforces people’s fears, giving them even more incentive to hoard. While real interest rates can be effectively negative if inflation exceeds the nominal interest rate, the nominal interest rate had been theoretically bounded by zero. Negative interest rates are often the result of a desperate and critical effort to boost economic growth through financial means. Negative interest rates may occur during deflationary periods when people and businesses hold too much money instead of spending. This can result in a sharp decline in demand, and send prices even lower. Often, a loose monetary policy is used to deal with this type of situation. However, with strong signs of deflation still a factor, simply cutting the central bank's interest rate to zero may not be sufficient enough to stimulate growth in credit and lending. Many financial institutions, which have millions or billions of dollars, store their excess cash at central banks for safekeeping. Normally, those institutions earn a small return on those funds, but in a negative rate environment, the banks get charged by the central bank for storing dollars. That increases the institution’s overall costs. It’s not that the central bank wants the money; rather, they’re penalizing banks for hanging on to their cash instead of lending it out. They want people and businesses to borrow more—at ultra-low rates—which should then help buoy economic growth. In recent years, central banks in Europe, Scandinavia, and Japan have implemented a negative interest rate policy (NIRP) on excess bank reserves in the financial system. This unorthodox monetary policy tool is designed to spur economic growth through spending and investment as depositors would be incentivized to spend cash rather than store it at the bank and incur a guaranteed loss. It's still not clear if this policy worked in these countries in the way it was intended, and whether negative rates successfully spread beyond excess cash reserves in the banking system to other parts of the economy. In both Europe and Japan, lending has not picked up in any significant way and both economies continue to struggle. Could GDP growth have been worse without negative interest rates? Possibly, though economists would have liked to have to see better growth from these countries. Earlier this year, the ECB reported that loan growth, which did pick up in mid-2015, was essentially flat quarter-over-quarter at the beginning of 2019 and down by double digits from years prior. That’s despite having a -0.5% overnight rate. (In September, the ECB cut its rate from -0.4% to -0.5%.) . Could negative rates impact my investments? Yes. When rates fall, bond yields tend to drop, which makes them less attractive to income-seeking investors. The main alternative to bonds, then, is dividend-paying blue-chip stocks in stable income-earning industries such as utilities, telecoms and real estate. When rates fell after the recession, stocks in these industries soared. While that’s good for equity investors, that search for yield can make these stocks expensive. You should also see company earnings rise as businesses borrow more and invest in their operations, which is good for stocks. In Conclusion : Negative rates are bad, they will cause bank runs here in the US with people rushing to get their cash out before they start getting charged fees for letting their money sit in the bank .





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