I possess a proposition for you. I’d like to borrow $100. Just how much are you willing to pay me for the privilege?
I know, I know. The custom is definitely that when I borrow money from you, I pay out interest. However in the upside-down, inside-out ” new world ” of “negative interest rates,” which so far has gone farthest in Europe, you have to pay me. On some Danish mortgages, The Wall Street Journal reports, homeowners are actually getting monthly obligations from their banks, not the opposite way round.
Negative interest rates, that the Bank of Japan a week ago became the latest central bank to introduce, have been in existence for a long time now. To get economies growing, central banks try to lower rates of interest. With lower borrowing costs, “real” investments in buildings, factories, bridges, take your pick, which are prone to possess a profit rate of five or 10 or 15 percent ought to be even more attractive.
If businesses can take a loan at one or two or three percent and use the proceeds to finance investments likely to repay at several times that, they might well discover the prospect irresistible. Hence, monetary easing promotes real economic growth. People get the interview. Supplies get bought. Economies pull out of recessions and start delivering higher living standards.
Except that, since 2008, central banks have lowered and lowered and lowered interest rates, oftentimes basically to zero, and growth continues to be anemic, especially in Europe and Japan. In reaction, one recourse is to stop working on interest rates and just support vast amounts of all types of loans, known as “quantitative easing.”
But another is to boldly go below the “zero lower bound,” as it’s called, and charge negative interest, out of the box being carried out in Sweden, Switzerland, Denmark, the eurozone and today Japan. Large financial institutions that deposit money with central banks now pay for the privilege of doing so.
Why would anyone ever pay negative interest?
As always in economics, this will depend on your alternatives. Actually, banking probably started out with negative rates of interest. Within the ancient world of metallic currencies and widespread thievery, you may well wish to pay five per cent, say, to have some security company store your gold in its vault and protect it from punctures for you personally.
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Once such operations determined all their customers never withdrew all their gold all at one time, it wasn’t a reach for them to start lending a lot of it to individuals who were prepared to pay positive interest in order to finance profitable ventures of one kind or any other. Eventually the “banks” themselves, as they came into existence called, started to offer positive interest to attract new depositors to help keep the profitable lending going.
Why don’t banking institutions, or other people charged negative interest, just withdraw the money and keep it in cash?
Your $100 will likely be safe for that year if you do not lend it to me. Place it under your mattress. But if you are a big lender with billions of dollars on deposit, how big a mattress are you able to get? Additionally, there are the problem, for us small-timers, that cash no more works for most of the transactions we want to make. Ever try sending Amazon.com cash? Even when banks were charging us on our deposits, we might still need them. Besides, they charge us for everything else. Why not deposits?
Will negative interest rates work? This will depend what goes on towards the prospective returns on those “real” investments central banks want to encourage. If they hold up and because negative-interest finance cost less, the result should be a boost to real business activities.
But if the brave new looking-glass realm of negative interest rates persuades potential investors everything is going to hell, those prospective returns with it, then the policy backfires.
Fingers crossed naturally we all jump down this rabbit hole!
