Today we explore the topic of interest rates, and we will see what negative interest rates are and how they operate.
What is a negative interest rate?
A negative interest rate is a loan, granted by a financial entity, where you do not pay to take money but you are paid to access this loan.
A debtor who is paid to take a debt.
Fantastic.
BUT What do negative interests on the economy really mean?
Interest is the amount that you pay to the bank to borrow money for your business or family activities, or it is the money that is credited to you by the bank to hold your funds in your bank account.
The low rates are created to push banks to increase lending and not keep a lot of liquidity stored in their accounts, flirting with customers that need to access these low-cost loans.
High interest rates are used to push people to spend less and try to keep inflation under control by cooling the economy.
The opposite is created by lowering rates.
The ECB European Central Bank started with negative rates in 2014 while the central bank of japan started in 2016
With negative rates, banks will begin to lose profit from the money deposited in their customers’ accounts.
Negative interest also means that deposit accounts and money held on checking accounts will be paid at zero or you will have to pay to keep yopur accounts in the bank. In this case the bank could decide to absorb this cost from their customer if they take other products of the bank such as insurance, mortgages, etc.
It happened in denmark that a bank applied a rate of -0.5%
Consumers are so discouraged from keeping cash in their checking accounts and are therefore pushed to spend. This affects the entire economic chain, both private and corporate.
The costs for loans to the public will certainly be higher than those that the bank will have, after all it is their business
In the case of negative interest decided by the central bank, consumers do not necessarily have to have negative interest on their loans as well.
At the moment, we do not fully understand the real consequences of negative interests on the real economy, despite the fact that these seem an excellent thing to the man in the street.
Theoretically, low or even negative rates serve to push the economy with greater consumer spending, a greater propensity to borrow and a growth in consumption and therefore a growth in inflation.
With inflation, or the growth of consumer prices, there is a loss in value of the currency of the country that is the victim,
which means a greater possibility of selling their products abroad given their lower value at the exchange rate with competitors, another boost to the demand for goods and services.
All good, if it happens.
The countries that are now protagonists of this financial policy based on negative rates have had problems with chronic slow growth and are therefore in deflation.
Deflation encourages banks and people not to spend their money.
Deflation leads to the cycle more saving less spending. negative interests are seen as a method to discourage this cycle and indeed reverse it
Negative interests can have many negative effects on the economy and the population. People may decide to own their savings in physical currency, creating a run at ATM instead of keeping their cash in bank accounts and then paying the banks fee.
Financial bubbles are another effect, people could borrow to an unsustainable level and then create a financial bubble, with all that goes with it. Do you remember our toxic assets?
Which means making risky investments with money that savers cannot afford to lose. In the event of a crash the situation would be really problematic.
Negative interest then affects savers and bond investors. Savings are no longer remunerated and bond yields go to 0,
the risk is no longer correctly remunerated, creating market distortions, which leads to an increase in the risk in the investment portfolio to maintain the same level of remuneration.
Think about how all pension funds and bond funds are affected
Companies take debt money not to create new production lines or increase their workforce, but to buy back their shares, artificially increasing their value on the market
Banks are also affected, as this action greatly lowers their profits on loans and other products.
Negative rates can be seen as paradoxical and controversial
Negative rates on various bonds lead to not placing the bonds on the market, since in a normal market no one lends their money without having an economic return.
On the contrary, we must mention the Safe haven bonds have a low if not non-existent yield, but we are talking about bonds issued by countries considered “safe” and “unshakable”.