globalEDGE Blog: The Implications of Negative Interest Rates

The Implications of Negative Interest Rates

The Bank of Japan reduced interest rates to below zero on Friday, after years of keeping them in the positive range. The negative interest rates will be placed initially on reserves valued at 10-30 trillion yen and will apply only to new reserves that financial institutions deposit at the central bank. The goal is that the reduction would cause the real interest rates to decrease, thus stimulating consumption and investment. This policy will decrease rates for lending and isn’t supposed to negatively affect banks. The Bank of Japan will be dividing the account balances into 3 tiers, and the interest rates placed depending on the type of reserves that are placed in the Bank of Japan.

Several central banks in Europe have cut important interest rates to below zero for over a year, and Japan was the last country to further reduce interest rates. The purpose depended on the central banks. For some, it was an attempt to fuel the economy after past attempts failed, and others wanted foreigners to move their money out to another location.  The European Central Bank was the first bank to reduce rates to below zero 1.5 years ago. Sweden has negative rates, Denmark uses negative interest rates to protect their currency’s peg to the Euro, and Switzerland lowered their deposit rate to below zero.  About a third of the debt that was issued by Eurozone governments has negative yields, meaning investors who are holding until maturity are likely not getting their money back.

The beginning of negative interest rates is a signal that the traditional monetary policy options are no longer effective, and that more measures must be pursued to keep the economic recovery on track. Negative interest rates imply that instead of depositors receiving money from deposits made, depositors have to pay to keep money in the bank. In theory, very low interest rates encourage corporations to borrow money and make investments for growth, such as in plants or equipment, and encourages households to make large purchases. The private sector has a saving surplus, and has been seeking to minimize debt rather than increase profits. Differing global monetary policies have failed to meet growth and inflation goals, and the manipulation of the exchange rates are risking the devaluation in currency.

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