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.