Way back when I studied economics, I don’t actually remember learning what a ‘negative interest rate’ was. In fact, even a few years ago when I taught graduate-level economics (a whole other post), I don’t remember it being in the curriculum, or even being asked about the topic. That was then, however. These days, negative interest rates are a thing, and for those of us who never bothered to think about them too much, now is the time.
Luckily for those who need a crash course in negative rates, the Federal Reserve Bank of San Francisco has put together this neat and concise primer on the topic. Their focus is on the the Bank of Japan (BOJ) which last month surprised the markets by implementing a negative rate policy, but their explanations work for any country.
In the case of Japan, and in the case of any country worried about deflation, low rates are the way to go and negative rates are the last-ditch extension of that. Think about it: if people are not spending money, then prices get bid down and down again in a never-ending cycle. If you want them to spend money, you need to make sure that they do not have the incentive to save it, which means doing away with high interest rates. And yes, negative rates are the extreme opposite of high rates.
Actually, in the case of Japan the negative rates are more about changing the behavior of banks, rather than individuals. The Bank of Japan wants the banks to lend, so rather than give them any interest on money deposited with the Bank of Japan, they are (subject to some specific conditions) actually charging them for leaving money parked. So far, it seems to be working: Japan’s largest banks have now announced that they will cut the rates they charge on mortgages.
As the San Francisco Fed points out, moving to negative rates can hurt bank profits, which is something to consider. That is, banks typically have a ‘spread’ between what they pay on deposits and what they earn on loans. If they have to factor in what they have to pay on their own deposits – well, that’s not exactly a positive. They could of course try to pass those ‘costs’ on to their own customers, charging them a fee for depositing with them, but it’s hard to see how to make that stick. Customers would quickly find something else to do with their money, even if it means putting it in a box under their beds.
Japan is not the only country experimenting with low interest rates. Sweden, Denmark and Switzerland have also moved into below-zero rates, and at a press conference in December Bank of Canada Governor Stephen Poloz hinted that it was a tool he would consider as well. Not surprisingly, even the hint of doing that sent the Canadian dollar into a tailspin. Officials from the U.S. Federal Reserve and the Bank of England have toyed with the idea publicly as well.
In itself, using negative rates may not make much difference to individual economies, but the fact that they are now on the table as a tool is significant in itself. Here we are a good six or seven years past global recession, and deflation is still a major concern in many parts of the world. It is a strange economic time to be sure, which is why economic textbooks might well need to be re-written.