In mid-February, the Bank of Japan (BOJ)—Japan’s central bank—lowered its funds interest rate to -0.1 percent. It meant the BOJ would begin charging private Japanese banks for holding on to excess cash reserves.
This negative interest rate policy (NIRP) is not unique to the BOJ. By “going negative,” Japan joins the European Central Bank and the central banks of Sweden, Switzerland and Denmark.
Why are so many central banks doing this? Economic growth in several developed countries has recently slowed down as businesses have grown accustomed to low rates. Central bankers hope that pushing rates down into negative territory will help their economies resume expansion.
How it Works
To understand how NIRP is supposed to help, try imagining what would happen if your personal bank accounts had negative interest rates. How would you react to paying to save money each month? What changes would you make to your finances?
You probably would reach the same conclusion as most people: “I need to minimize the money in my accounts.” One option would be to invest the money so that it has a chance to grow; another option would be to spend it on a major purchase before you need to pay any interest.
These are essentially the same responses governments are hoping to incite from investment banks and large corporations. Economic slowdowns cause businesses to focus on saving money when central banks need them to spend it. The savings penalty created by negative rates squeezes hoarded cash out of corporate accounts and into new business investments.
NIRP also provides a strong signal that a central bank will do whatever it takes to promote healthy inflation and fight against a slowing economy. This means a NIRP can become a type of rallying point for businesses, creating enough confidence in future growth that companies proactively expand and turn their growth expectations into reality.
Effects at Home
The BOJ’s move to negative rates has raised questions about the future of America’s monetary policy. In a world where several central banks have continued to lower rates, the United States has been trying to raise them. Economists and investors wonder whether America will be able to continue bucking the downward trend or if its rate hikes need to be stopped.
Rising interest rates often accompany economic success. Because the United States’ economic recovery has drastically outpaced most other developed economies since 2009, it needed to start increasing its interest rates first. As its economy improves, its interest rates should need to be raised.
However, central bank rates must be compared to each other. Although the United States has only recently started raising rates, rate cuts in other countries have led some to believe that its relative rates are increasing too quickly. If the relative rates climb too much, the dollar could become too strong and other countries would stop buying U.S. goods, hurting the chances of further U.S. growth.
Will America Go Negative?
While anything could happen in the future, most experts currently believe U.S. rates will not go below zero. The U.S. Federal Reserve has said it studies negative rates and simulates them for bank “stress tests” but doesn’t envision needing them. After years of aggressive quantitative easing and zero percent interest rates, it’s unclear what new benefits negative rates would even provide for the U.S. economy.
It’s also important to remember that countries can influence rates in both directions. As the world’s two largest economies, the United States and China are in position help stimulate other economies through trade. If their growth and consumption become strong enough, the world economy will improve and rates in other countries will be brought above zero.
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This article was written by Advicent Solutions, an entity unrelated to Guidestream Financial, Inc.. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Guidestream Financial, Inc. does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. © 2014 Advicent Solutions. All rights reserved.