Imagine going to the bank to park your hard-earned money in a fixed deposit. Imagine also the scenario, where instead of welcoming you with open arms, besides tea and biscuits, the branch manager informs you that you need to pay money to the bank for your deposit. As of now, three countries have adopted a monetary policy of having negative interest rates, namely Switzerland, Denmark, and Japan. This means that people have to pay money to deposit their money with banks, which seems like an incredible and mind-boggling approach to take. So why is it that some countries think that this is the way forward?
Firstly, it is important to understand the true meaning of what it is to have negative interest rates. Let us consider the public’s point of view. Every person aims to get their money working for them and to get the maximum possible returns on a set capital. In most countries, the public has the safe option of depositing funds with the bank and getting a fixed rate of interest for a while, thus giving them some additional money in a more-or-less risk-free manner. However, when a country has negative interest rates, it means that a person has to pay to keep their funds in the bank. Naturally, it is very unlikely that one would want to pay someone to keep their money for them, and people search for other places to deposit their funds, investments that will give them some returns. This, of course, is what the government intends to do with a negative interest rate policy.
But what exactly does the government hope to achieve by taking such measures? First, the context with which this policy was first implemented must be understood. This move was first implemented by the Swedish central bank, who cut their deposit rates to -0.25% in 2009. In 2009, the world was still dealing with the effects of the market crash that had occurred in the previous year. The volatile situation of the global economy meant that people were unwilling to invest and preferred to hold onto their cash to wait for the economy to revive before investing their savings. However, without the initial investment from the public, no new projects were being started, no new jobs were created. This caused a deflationary spiral, where people held onto their funds until the economy revived, but the economy was not picking up because of a lack of investment. To combat a deflationary spiral from taking place, this drastic measure was taken for people to stop saving and start investing more.
Negative interest rates also apply to commercial banks, in that there is a cost if they want to park their funds with the central bank. This again incentivizes banks to lend money to the public at a lesser rate, which thereby allows people to invest more in the economy, spurring growth again. However, this comes with its disadvantages. A lower interest rate means that the income of the bank is severely cut, and their only source of income becomes the money generated by the public depositing their money in the banks which, as previously discussed, is not a large amount. This means that commercial banks will be less willing to lend, going completely against the principle with which the policy was implemented in the first place.
The second problem this approach may pose is that people may want to withdraw the money they have kept in banks and keep it with themselves in the form of hard cash. Such a situation happening on a large scale will lead to a lack of funds available with the banks, meaning that they will be forced to increase interest rates, again achieving the opposite effect than what was planned.
Negative interest rates are also implemented in countries with a low inflation rate to boost the inflation rate. It is common knowledge that some inflation is required for the growth of the economy, and inflation takes place when there is more money supply in the economy. This also opposes the deflation spiral that is so common after periods of economic downturn.
Overall, negative bank rates are a drastic measure to take. It forces people to put their savings into riskier investments where returns are not guaranteed and are not ideal for the older part of their population. However, sometimes such drastic measures are required to spur the growth of the economy, and negative actions may have positive results.