The Rise of Negative Interest Rates
As bizarre as the idea of negative interest rates may sound, they are a reality today in parts of the word as five central banks have set their policy rate below zero.
The biggest question that arises from this action is conceptual – how can a central bank institute negative rates? Once the “how” is understood, a host of questions arise, such as; what do negative rates mean for average investors and consumers? Will banks start paying you to borrow money? Conversely, will you have to pay them to hold your savings? Should negative rates be instituted here and are we close to seeing them? This piece addresses the odd case of negative interest rates and attempts to tackle all of these questions.
The What, Where and Why of Negative Interest Rates
A central bank sets the interest rate paid on deposits that are held with it and influences the rates that are charged on loans that financial institutions make to one another. The deposit rate, or the policy rate, is a key monetary policy tool that is intended to influence the path of economic growth. Banks use the policy rate to determine their short term rates for lending and savings products and changes in this rate are generally passed on to consumers. Policy rates are lowered to spur borrowing, which is designed to lead to spending when the economy needs a boost, and rates are increased to pump the brakes if it is believed that demand may be overheating and inflationary risks are increasing.
Negative interest rate policy is when a central bank sets its policy rate to a level below zero. This effectively means that commercial banks are charged to deposit money at the central bank, and a shift into negative territory was uncharted territory until recently.
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