Negative interest rates, in practice, provide a means of taxing commercial banks for the ability to hold their reserves within the central bank. Many established nations, such as Switzerland and Japan, are now deploying negative interest rates. United State’s markets are even placing close to a 10% chance on the Federal Reserve introducing negative interest rates within the coming 12 months.
The theory behind negative interest rates creating growth within a nation and its markets is fundamentally sound on paper. For example, to steer clear of paying out on their surplus of reserves, commercial banks would instead be incentivized to give out loans. In addition, nations exports could become more desirable through the negative interest rates theoretical ability to weaken said nation’s currency. Furthermore, negative rates should lead to short-term government bond yields falling, which would entice investor’s to put their money into the equity markets. Finally, with more competitive exports comes more costly imports and inflation, which could be a positive for certain nations. If a given country struggle’s with consistently not reaching its target inflation, negative interest rates could aide in the effort to solve that problem.
However, putting negative interest rates into practice have not guaranteed these encouraging results. Negative interest rates have been shown to narrow the margin between the rates at which a commercial bank can borrow and offer loans. This thin gap coupled with the hardships accompanied with establishing negative rates on depositors may lead to commercial banks lending less and raising rates on consumers elsewhere. For example, Scandinavian banks have actually raised their rates for homeowners looking to borrow since the rollout of negative interest rates.
Another issue is that equity markets do not always strengthen due to negative interest rates. Commercial banks within major equity markets such as the United States and Japan account for a sizable fraction of total market cap. Due to negative interest rates tendencies to cut the commercial banks profits, major stock indexes may not see any of the intended growth.
Japan has also recently proven that negative rates do not always devalue the nation’s currency. Since the Japanese Central Bank implemented negative interest rates, the Japanese Yen has actually appreciated 5.4% against the USD. This may not be a perfect example though, for this is due to Japan’s risk aversion, and Japan is historically extremely risk averse.
The final concern with negative rates being put into place is the limit to how negative interest rates could possibly go. If rates were to fall negative enough, commercial banks would be forced to pass them onto their depositors, destroying the foundation of consumer banking. If a consumer were to have to pay to hold their money at a commercial bank, they would have every incentive to convert their accounts into physical money.
Central banks are implementing negative rates as a method of stimulating growth and inflation of their currencies, but the policies attached with the rates are yet to be perfected. While central banks try and create an environment in which their negative rates will have their intended effects, the potential for unforeseen ramifications will exist, and investors should remain observant.