Negative Interest Rates

Staying positive in a negative interest rate world just got a little easier. Sweden’s central bank, one of the world’s first to lower benchmark interest rates to below zero, this week raised its rate up to zero from negative 0.25%, or -0.25%.

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A negative interest rate from a bank means that instead of depositing monies and earning interest, the depositor pays interest over time. The concept has been said to signify ultra-safety of deposits thus providing “value” to the depositor.

What are negative interest rates? What do they mean to an economy?

  • Negative interest rates may sound crazy, but they have existed since at least 2014 in Denmark. A negative interest rate from a bank means that instead of depositing monies and earning interest, the depositor pays interest over time. The concept has been said to signify ultra-safety of deposits (especially in a weak or weakening economy) thus providing “value” to the depositor.
  • Negative interest rates can signify too much idle cash at banks that is not being invested in businesses or other parts of an economy. In this case, an economy is so slow that banks have “lost” revenue because no one is borrowing to buy homes or finance a business. So, the bank starts charging (instead of paying) for deposits.
  • A central bank of a country may lower rates below zero to stimulate a weak or weakening economy thus preventing recession. The thinking being that if a depositor cannot earn interest on cash sitting in a bank, then she or he is going to go out and spend the money or even borrow more money to buy a home or business.

Negative interest rates in Denmark, Sweden, Japan and the European Central Bank were originally intended to be a short-term measure to stimulate economies or fend off recession. The thought was with low economic activity back in 2014-2015 in Europe, negative rates would spur spending, borrowing and even increase real estate values (think low rates = easier to buy a home). And for a while the program worked.

But over time, call it human nature (?) or leaving rates below zero for too long (?) several of the early benefits of negative interest rates have led to weaknesses – keeping stagnant companies alive with cheap debt and lowering bank profits across the board as in Germany. Other negatives of continued negative interest rates include potential inflation and a weaker currency.

Stay tuned for more on negative interest rates. The process of “normalizing” interest rates (meaning if and when central banks start raising interest rates) will definitely cause a jolt to the worldwide financial system and to equity and bond markets. But if done in a gradual way, amidst a slowly growing economy (kind of like we have now in the US) the “jolt” could be less jarring but nevertheless a jolt. For now, thank you Sweden for being the test case.

 

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