The Fed­er­al Reserve remains com­mit­ted to rais­ing the Fed­er­al Funds rate, a bench­mark that can affect the inter­est rates charged on many types of con­sumer cred­it.  But abroad, a dif­fer­ent exper­i­ment is under­way.  As of late April 2016, six for­eign cen­tral banks have adopt­ed neg­a­tive inter­est rates in an effort to stim­u­late their nation­al economies.  On the list are the Euro­pean Cen­tral Bank, Den­mark, Swe­den, Switzer­land, Hun­gry and Japan.  Tak­en togeth­er, these economies rep­re­sent about one-fourth of glob­al eco­nom­ic out­put.

Why would a cen­tral bank low­er inter­est rates?  There are two fun­da­men­tal rea­sons.

  • The first is to encour­age con­sumer spend­ing and busi­ness invest­ing by mak­ing it cheap­er to bor­row and less lucra­tive to hold onto cash.
  • The sec­ond rea­son is to low­er the val­ue of the nation­al cur­ren­cy in order to make exports more appeal­ing to trad­ing part­ners and to cre­ate an expec­ta­tion of future infla­tion which may fur­ther stim­u­late cur­rent spend­ing.

The push into neg­a­tive ter­ri­to­ry reflects the same goals, but it revers­es tra­di­tion­al eco­nom­ic con­cepts by turn­ing bor­row­ers into cred­i­tors and cred­i­tors into bor­row­ers.  That’s because com­mer­cial banks actu­al­ly lose mon­ey on their short term deposits in the cen­tral bank, while large busi­ness cus­tomers and even some con­sumers may have to pay to deposit their cash safe­ly in a bank.  Bor­row­ers get paid while savers get penal­ized.

The great­est fear regard­ing neg­a­tive inter­est rates is a mass exo­dus from the bank­ing sys­tem – why would some­one put a $1 in the bank and ful­ly expect to only get 95 cents back?  But ear­ly indi­ca­tions are that banks and their cus­tomers seem to be weath­er­ing the tran­si­tion albeit with low­er mar­gins and addi­tion­al fees.  After all, con­sumers might be able to keep cash under a mat­tress but it is dif­fi­cult to pay bills or buy mer­chan­dise online with cash.

How low will rates go along remains to be seen along with whether reverse eco­nom­ics will strength­en the glob­al econ­o­my or cre­ate new chal­lenges.  One thing is cer­tain, neg­a­tive rates will either mark the start of a new era for the world’s cen­tral banks, or final­ly expose the lim­it of their pow­ers.