9 Insights About Negative Interest Rates

by Diana Drake

How low can interest rates go? As it turns out, below zero. This is by no means an icy proposition as that might suggest, but instead a strategy to heat up economic growth. It was a hot topic in September 2019, following comments by former Federal Reserve chairman Alan Greenspan. He suggested that negative interest rates, in play in other parts of the world, were on their way to the U.S. But not everyone is convinced that the promise of negative interest rates is a positive economic policy. For one, the current Fed chairman is dismissing the idea. Check out these negative interest rate insights:

  1. First, a refresher. Zina Kumok, a financial blogger who has written several columns for Wharton Global Youth, starts with the basics. “Interest is the cost of using someone else’s money. When you borrow money, you pay interest and when you lend money, you earn interest. The interest rate is the price borrowers pay for the use of money they do not own – like that 6.8% rate I paid on my student loan. Interest can be bad if you’re borrowing, and good if you’re investing money. If you open a savings account at the bank — which means you are actually lending money to your bank – you earn a very low rate of interest, usually around 0.06%. So, if you put in $1,000, after a year you will only earn 60¢. Different financial products earn different rates of annual interest – some more than others, often depending on the riskiness of the investment.”
  1. Central banks like the Federal Reserve in the U.S. control monetary policy for countries and also hold cash for banks. When the U.S. Fed lowers interest rates, it is good for some and bad for others. Joanne Im, a high school student from New Jersey who was a champ on her school’s economics team, explained the double-edged interest rate sword like this: “Let’s say you want to start an online business and need a few computers to get it running. If you don’t have enough cash to pay for the computers, you can go to the bank and ask for a loan. When interest rates are low, you can take the loan and not worry about paying a large amount of interest for that money. This seems great, until you remember that for every borrower there is a lender. Imagine that you take the earnings from your computer business and put them in the bank for your college tuition. At the same time as the bank loans out money at very low interest rates, it also pays lower interest rates on any money that is deposited. This means that the interest you earn on your computer business profit will be quite small, making it harder to save enough for the things you will later need.”
  1. So, about those negative interest rates. Simply put, this is when interest rates actually drop below zero. As mentioned above, banks typically pay out interest to people who deposit money with them, use those funds to make loans to others and to maintain their cash reserves, and collect interest on that money from borrowers. In a negative interest rate environment, you might actually have to pay the bank a fee to hold your money and a lender might pay you to take out a loan. Top level, this means that banks and other financial firms would have to pay money to keep their reserves (cash holdings) at the Federal Reserve Bank or the European Central Bank, rather than receive interest income from those deposits. This is meant to encourage banks to lend out their money, instead of store it in cash, thus stimulating the economy.
  1. Negative interest rates are already a thing in Europe, Scandinavia and Japan, but have never been a serious possibility in the U.S. until recently. U.S. President Donald Trump is calling for them. In a recent tweet he said, “The Federal Reserve should get our interest rates down to ZERO, or less.”
  1. The U.S. interest rate is currently pretty low. On July 31, the Fed announced that the interest rate would be cut to 2.25%, the first cut since December 16, 2008. It cut interest rates by another quarter of a point on Wednesday, September 18. Following that move, Fed chairman Jerome H. Powell said that a weakening economy could require a “more extensive sequence” of rate cuts.
  1. Why even lower? The immediate cause for the U.S. is likely trade tensions, which have touched off an investor flight to the perceived safety of U.S. government securities. That has pushed interest rates lower. And that all piles on to a longer-term drift downward for rates, led by a slowing economy.
  1. Even though some see negative interest rates as a way to help the economy, questions remain. When rates turn negative, the end result is unclear. During a recent visit to the Knowledge@Wharton radio show on SiriusXM, Peter Conti-Brown, a Wharton legal studies and business ethics professor, said, “We simply don’t know how markets in the world’s largest economy would respond to this new world.” Would it lead to “explosive economic growth” or “high inflation that we never expected or … something new that might just be coming our way that we didn’t anticipate?”
  1. Consumers may feel the pinch – or not. In a separate interview with Wharton Global Youth, Conti-Brown added, “In other jurisdictions, the central banks have worked hard to shield consumers from negative interest rates. What it means in practice is that a high school student with a savings account would likely see no interest paid on that account, but would also likely be able to get much cheaper loans for college, starting a business, that sort of thing. It is also possible that the Fed (or another central bank) could experiment with deep negative interest rates such that consumers *did* feel that heat. In that case, those with a bank account would be charged for that service. A borrowing consumer would see even better loan rates, potentially negative rates themselves–meaning, banks would pay consumers for the privilege of lending them money.” Banks will also probably charge new fees to customers as a way to make up for the hit from negative interest rates.
  1. Wharton experts agree that the U.S. is more likely to see negative interest rates than not. And yet, Fed Chairman Powell is less bullish on the idea if the economy weakens. Following this Wednesday’s Federal Open Market Committee meeting, he said, “I don’t think we’d be looking at using negative rates. I just don’t think those will be at the top of our list.” As we often do, we turned to an economics-savvy high school student for the last word. Neha Narayan, 17 and a senior at West Windsor-Plainsboro High School North in New Jersey, has been closely following the negative interest rate debate. “What I think is interesting about negative interest rates is how they’ve had such varying levels of success,” says Neha, a competitor in the High School Fed Challenge, where teams analyze current economic conditions and recommend a course for monetary policy. “If we look at somewhere like Japan, we can see how detrimental the impacts of negative rates have been and how they’ve actually contributed to slowing down the economy even more. On the other hand, the Eurozone, after facing hard times and a sluggish recovery post-crisis, has seen a decent amount of rebound owing in part to their negative rates as well as the rounds of Quantitative Easing that have been implemented. Whether that’s directly due to the negative interest rates or other actions taken by the European Central Bank, though, is more unclear, which is why I think they’re a risky option for the U.S.”

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Conversation Starters

What is a negative interest rate?

What does Peter Conti-Brown mean when he says, “We simply don’t know how markets in the world’s largest economy would respond to this new world.”?

How does Neha Narayan feel about negative interest rates? Do you agree with her assessment or do you have a differing opinion?

5 comments on “9 Insights About Negative Interest Rates

  1. “Banks collect deposits to make loans” could be misleading. Banks need deposits to maintain reserves, not to make loans per se. Banks don’t lend deposits. Banks account for extensions of credit. Credit is not borrowing money. Credit is buying a durable good, like a house, over time in installments while simultaneously renting a portion of the good pending completion of the sale. The “interest” portion of a mortgage payment is equivalent to the buyer’s rent.

    Banks account for the sellers’ interest in goods sold this way by creating notes (accounting entries), and the sellers collect their rent (a portion of the buyers’ interest payments) by depositing the notes in a bank. These notes (corresponding to bank deposits) are themselves a form of money, but a bank requires reserves of “base money” (or a standard of value like gold in historical banking systems) to satisfy depositors’ demand for cash. Cash is money not deposited in a bank and thus not earning interest. In historical systems, gold coins and other standard commodities were cash.

    That said, here’s a question about negative interest rates. If my bank requires a fee to hold my deposit, why wouldn’t I withdraw the deposit and hold the cash instead? I have goods of similar value in my house all the time and don’t worry much about any possible theft, and a reasonably secure safe isn’t very costly.

    Doesn’t a banking system with negative rates drive demand deposits practically to zero? Doesn’t the policy only shift bank deposits from short term deposits, entitling depositors to withdraw a deposit on demand, to longer term deposits (like Certificates of Deposit) requiring depositors to withdraw a deposit only after a specified term?

    In the banking model described above, deposits represent the interest of sellers, during credit transactions, in the goods sold (or other collateral securing the credit) and the related interest of providers of cash reserves. In terms of this model, when does a banking system need longer term deposits (requiring the depositor to wait a specified period before withdrawal) rather than short term, demand deposits?

  2. “Interest is the cost of using someone else’s money” could also be misleading. Interest is the cost of participating in a credit transaction as described above. In a home mortgage, it is the cost of using someone else’s house (or a portion of the house not yet bought), not someone else’s money. In a car loan, it’s the cost of using someone else’s car. The car is the thing loaned, in whole or in part, for the duration of the credit transaction. Ownership of the car gradually flows to the buyer, so the part of the car borrowed (and thus subject to interest [or rental] payments) gradually decreases. Money itself is not loaned in these transactions. Money is a product of the transactions, created to account for the transactions.

  3. I believe the Fed’s operating profits are returned to the Treasury, so the Treasury effectively pays little or no interest on bonds held by the Fed anyway, and as long as the Fed continually refinances Treasury debt (buys new bonds corresponding to the Treasury’s principal payments on existing bonds), the Treasury’s bonds held by the Fed are effectively retired when the Fed buys them, even if they exist on the Fed’s books forever, so trillion dollar coins are a moot point.

    As legal tender, would this coin would be an asset held by the Fed (like gold in Ft. Knox), or would it be returned to the Treasury?

  4. While negative interest rates are a very interesting idea for stimulating US consumer spending, I agree with Neha Narayan’s sentiment that negative interest rates are yet to be proven as a way to increase spending. A good example that she presents is Japan. When negative interest rates were first implemented in Japan in Q1 2016, consumer spending was 299,000 billion Japanese Yen; in Q1 2024, consumer spending was 294,000 Billion Japanese Yen. Over the period of reduced interest rates, omitting the outlier of COVID-19, Japanese consumer spending has remained virtually stagnant, with its highest point since Q1 2016 being Q3 2019, at 305,000 Billion Japanese Yen. While it is apparent that the Japanese and US economies have many differences, I do not think such a radical policy should be implemented in the largest economy in the world without having proved itself many times over, given the potential for unintended effects.

    Another reason negative interest rates should not be adopted now is that consumer spending does not need to increase in the US. In our current environment of high living costs becoming even more untenable, negative interest rates would likely harm the US economy. After the economic stimulus implemented during COVID-19, seeking to stave off consumer spending falling drastically, inflation increased very rapidly. The Federal Reserve has held federal funds rates above 5% for the past two years for this exact reason. If the Federal Reserve were to drop rates to such extreme lows, inflation would increase significantly.

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