Cashing In: How to Make Negative Interest Rates Work

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Get ready for the future:

Cashing In: How to Make Negative Interest Rates Work

By Ruchir Agarwal and Signe Krogstrup Español, Français,

blogs.imf.org

How low can you go?

In a cashless world, there would be no lower bound on interest rates. A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter a severe recession. The interest rate cut would transmit to bank deposits, loans, and bonds. Without cash, depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy.

When cash is available, however, cutting rates significantly into negative territory becomes impossible. Cash has the same purchasing power as bank deposits, but at zero nominal interest. Moreover, it can be obtained in unlimited quantities in exchange for bank money. Therefore, instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.

Because of this floor, central banks have resorted to unconventional monetary policy measures. The euro area, Switzerland, Denmark, Sweden, and other economies have allowed interest rates to go slightly below zero, which has been possible because taking out cash in large quantities is inconvenient and costly (for example, storage and insurance fees). These policies have helped boost demand, but they cannot fully make up for lost policy space when interest rates are very low.

 

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How Negative Interest Rates Work

How Negative Interest Rates Work

Policymakers in Europe are choosing an unconventional strategy of negative interest rates. What could happen?

www.investopedia.com

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.

 

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https://news.yahoo.com/strategist-n...-be-the-most-hardcore-morphine-203601775.html

“The U.S. economy is still relatively solid,” Chris Konstantinos, chief investment strategist at RiverFront Investment Group, told Yahoo Finance’s On the Move. “Negative interest rates should be reserved for absolutely the most hardcore morphine for a patient that’s in the ICU. We are not necessarily projecting that the U.S. economy is going to be in the intensive care unit over the next couple of years so I like to think that negative interest rates are still not all that likely in the U.S.”

Meanwhile, central banks In other parts of the world have already lowered interest rates to boost slowing economies in Europe and Asia. The drive toward the “zero bound” worries Konstantinos because more than $15 trillion of sovereign debt now trades at negative yields.

Getting back less than you invest is ‘bonkers’
The German government auctioned close to $1 billion in 30-year bonds Wednesday that yielded negative 0.11% but it failed to sell all of the $2 billion that was brought to market.

“It sort of bends the mind a little bit thinking about the idea, the concept of negative interest rates, the idea of giving someone else, a sovereign, your money and then at the end of that loan getting back less than you gave them to me is kind of bonkers,” he said.