Negative Interest Rates: What Are They And Should We Be Concerned?

By | May 18, 2016

negative-ratesFor quite some time now, the financial world has been throwing around the buzz-term ‘negative interest rates’ that has some concerned and others confused, but what exactly are negative interest rates?

A Negative Interest Rate Policy is enacted by a central bank (ie: the U.S. Federal Reserve) whereby the central bank charges depositors to keep their money with the bank. Basically, rather than the bank paying you for having a deposit account (ie: interest earned on any funds in your account), you would have to pay the bank in order to deposit your money with them. This type of policy is generally instituted during deflationary periods in order to encourage banks to lend money and encourage consumers to borrow and spend rather than save money.

The theory behind this type of policy is that the Fed would make banks pay to keep their excess cash with the central bank and these banks will instead put their excess cash to work by lending it out to earn money on it through interest paid back on any loans it makes to consumers. Consumers will then spend the money they borrowed thereby stimulating the economy.

While in theory this may seem like a good idea, experts caution that in practice the results may be less than desirable. Economists and analysts have warned that the impact of negative interest rates could be twofold:

  1. The average consumer will likely see lower interest rates on savings, higher bank fees, and higher deposit requirements, all of which will likely lead consumers to stash more cash under the mattress rather than deposit it with a depository institution. This would rob lenders of an important source of funding, making them less willing or able to lend.
  2. Banks and financial institutions will have to absorb some of the cost of negative rates themselves and when they do, profit margins will tighten, leading to the possibility that they may become even less willing to lend.

In both of these instances, a policy of negative interest rates has the potential to have the opposite effect of what was intended.

Despite the risks associated with negative interest rates, we have seen several countries institute this type of monetary policy which has many saying ‘Denmark, Switzerland, Sweden, and Japan are all doing it, are we next? ‘

The short answer is no. The U.S. is not likely to embark on a negative interest rate policy anytime soon.

If we examine the countries that have embarked on this type of policy, we can see why negative interest rates may be an appropriate course of action. In Denmark and Switzerland for instance, negative interest rates are being used to keep the value of respective currencies from rising too much and too quickly. For the Eurozone, this policy has been enacted to stimulate growth and raise inflation which is currently below 0 and thus well below their target of 2%. The hope for the Eurozone is that negative interest rates will prevent them from going into a deflationary tailspin, which would derail their economic recovery. The current shortage of credit and unemployment, that is only slowly receding in the Eurozone, are much more reflective of persistent economic weakness than what we are currently experiencing in the U.S. This means negative interest rates may be more appropriate for these economies than our own. This isn’t to say that the theory should be ignored altogether.

Both Fed chair Janet Yellen and former Fed chairman Ben Bernanke have commented that the Negative Rate Policy is worthy of consideration; however, in March, Bernanke noted that he did not foresee the Fed instituting such a policy anytime in the foreseeable future. Additionally, the Fed raised interest rates this past December in a move that signified a strengthening economy. A move in the opposite direction towards lower or even negative interest rates thus seems highly unlikely.

This is good news for the mortgage market as those economies who have instituted a policy of negative interest rates are currently struggling in this uncharted territory with no clear guidelines on how to reconcile negative interest rates with mortgage lending. Only time will tell whether this radical approach presents a viable and responsible solution for struggling markets and economies.

 

 

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