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  • When the economy is in crisis, central banks take center stage.

  • Central banks are charged with keeping prices stable

  • and ensuring economic growth, among other responsibilities.

  • To that end, they have a range of tools at their disposal,

  • including controlling the supply of money, setting interest rates

  • and regulating private lenders.

  • But one idea being talked about as a way to shore up a shrinking economy

  • has the potential to turn the way we think about money upside down.

  • Negative interest rates.

  • In June 2014, the European Central Bank began a great economic experiment.

  • Faced with slow economic growth and inflation way below the bank's target rate,

  • the bank did something revolutionary. It began to charge a negative interest rate.

  • To understand why this was so radical, it's important to think about how interest rates work.

  • Anyone lending money usually expects to be paid a fee, known as interest,

  • to cover the risk or inconvenience of not having their cash to hand.

  • We see this with banks paying interest to savers and consumers paying interest on home loans.

  • The cost of borrowing, as a percentage of the original sum loaned, is the interest rate.

  • But negative interest rates turn the world upside down,

  • with borrowers charging lenders for holding onto their money.

  • So, what are central banks trying to achieve by making interest rates negative?

  • Imagine a big lever that they push back and forth as they attempt to keep the economy on course.

  • When central banks transact with major financial institutions,

  • changes in the rates received by these lenders gradually ripple out

  • through the wider network of commercial clients and consumers.

  • When prices are rising and there are fears that the economy is expanding

  • at an unsustainable rate, central banks pull back the lever

  • and raise interest rates, making loans more expensive.

  • But if inflation is falling and the economy isn't growing

  • as fast as it could, central banks push the lever

  • and lower the cost of borrowing to stimulate demand and encourage spending.

  • But what happens when interest rates are already low and there isn't enough lending and spending

  • to spark the economy back to life?

  • Central banks can charge financial institutions for not putting their money to work.

  • In the same way that you or I might put any spare cash into a savings account,

  • commercial banks store their reserves with central banks.

  • In a world of negative interest rates, instead of paying interest on these savings,

  • the central bank charges financial institutions for holding onto them.

  • The idea is to encourage banks to lend this money

  • to consumers and businesses, even if they don't expect a big return.

  • As consumers spend and firms invest for the future, the economy begins to grow again.

  • So how have negative interest rates worked out in the real world?

  • In the wake of the Great Financial Crisis, central banks across the globe

  • cut interest rates to fight the recession.

  • ...that's towards the aggressive end of the rate cuts...

  • ...another three quarter point cut...

  • ...unprecedented rate cut...

  • Just a few years later, five central banks found themselves facing further economic difficulties,

  • and took the plunge into negative territory, pushing their headline rates below zero.

  • Although intended as temporary measures, none of these institutions

  • have yet been able to lift rates above zero for very long.

  • The European Central Bank believes its negative interest rate policies

  • have been responsible for up to 0.5% of economic growth in the euro zone since 2014.

  • That may not sound all that impressive, but it still represented more than $65B of GDP in 2019.

  • Elsewhere results have been mixed, with the Swedish Riksbank abandoning

  • its negative interest rate policy despite failing to consistently reach its inflation target.

  • What's the biggest threat to negative interest rates then?

  • Cold, hard, cash.

  • Why watch your savings shrink when you can have a form of money that holds its value instead?

  • For large financial institutions dealing with billions of dollars,

  • withdrawing everything and stuffing it under the mattress isn't an option.

  • This means they'll accept the pain of rates being pushed a little way below zero

  • as the price of knowing their money's safe with their central bank.

  • But banks are wary of passing on negative rates to businesses and consumers with smaller balances,

  • who may find it easier to switch to cash rather than see their savings shrink.

  • If the difference between the central bank rate and the rates they pass on to customers gets squeezed,

  • that means banks stand to make less profit.

  • Although that may not sound like a tragedy, it's possible that pushing the interest rate lever too far

  • may put banks under too much pressure and cause them to lend less.

  • That's the opposite of what central banks are looking for when they lower rates.

  • Some economists think this 'reversal interest rate' is likely to be around -1% in the euro zone.

  • So far, the lowest central banks' main policy rates have sunk is -0.75%.

  • While Danish banks have offered mortgages with negative interest rates to prospective homeowners,

  • consumers still aren't quite being paid to borrow once fees are taken into account.

  • And saving for the future is more difficult than ever as savings accounts and pension funds offer low returns.

  • A negative interest rate policy may have its limits, and it certainly won't head off deflation or recession alone.

  • But in a world of low interest rates, don't be surprised if more central banks

  • look to turn the world upside down as economic uncertainty looms.

  • Hi guys. Thanks for watching our video.

  • Whether you're a borrower or a lender, we'd love to know your thoughts on negative interest rates.

  • Comment below to let us know, and remember: subscribe.

When the economy is in crisis, central banks take center stage.

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How do negative interest rates work? CNBC Explains

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    洪子雯 posted on 2020/06/26
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