Name: How Negative Interest Rates Work (And What They Would Mean for the Economy)
Uploaded: 2020-03-13T06:40:07.000Z
Duration: 9 min 20 s
Description: Thousands of YouTube videos with English-Chinese subtitles! Now you can learn to understand native speakers, expand your vocabulary, and improve your pronunciation...

President Donald Trump posted a strange tweet that started with the following sentence.

The Federal Reserve should get our interest rates down to zero or less, and we should then start to refinance our debt.

After the 2008 financial crisis, the lower band of the federal funds target rate hit 0%.

Now, if you're anything like me when I first heard of negative interest rates, you may have a hard time wrapping your head around the concept.

In what universe does a borrower get paid for holding alone?

Well, it's something that's already been implemented in Europe and Japan, but it stands as a drastic step for the U.

And if the president is looking to implement these rates, it's probably worth going over the concept.

So let's discuss negative interest rates and what they would mean for the economy on today's plane bagel.

Before we talk about negative interest rates, let's discuss the system as it currently stands.

Interest rates are, of course, the percentage of alone that you pay to a bank as a fee for borrowing from them.

They're also the rate that you receive for saving your money when you deposit, said money in a savings account with a financial institution, though, the two rates probably won't equal one another.

A normal interest rate will cost people for borrowing and reward people for saving straightforward enough right now, just like you are.

I banks have their own deposits, the deposit or lend their money to other banks on the overnight market and can choose to hold more than what's required of them.

S central bank thes deposits provide them interest.

The rate they receive on deposits with other banks is known as the federal funds rate, which is a market determined rate.

And the rate for deposits at the Fed is no.

As the interest on excess reserves rate the Federal Reserve uses the IA, we are to change the federal funds rate since they can't control the rate directly and the two are closely tied to one another.

Now, when the economy is weak, the Federal Reserve will lower its Io E.

Which in turn should bring down the federal funds rate as a way to discourage banks from saving their money and to encourage them tow lend it out as a way to boost business activity.

But what happens when the Federal Reserve pushes its rate below zero?

Well, banks would begin losing money on their deposits, and, in theory, a negative i A We are would lead to a negative federal funds rate, meaning that banks would also charge one another for holding their money on the overnight market.

This will trickle down to affect all other savings accounts within the economy.

A negative interest rate will likely mean consumer savings accounts will have their returns plummet to zero.

And these accounts may also experience a negative interest rate.

Since the bank will be paying to hold the money you deposit with them, though, banks may choose to simply absorb the cost to keep customers who may purchase other products like insurance, financial instruments, things like that.

Either way, consumers will be discouraged from holding money in savings accounts, and with both banks and the average person being incentivized to use their cash, we could see heightened business activity as both parties increased their spending, investing and lending, which is clearly the intent of such a move.

But this brings us to an interesting point.

What do negative interest rates mean for loans?

Will banks and consumers be paid for borrowing money?

It depends if the lowered I we are rate were to bring about a negative federal funds rate as it should.

In theory, it would mean that banks would earn money when they borrow on the overnight market so a bank could effectively borrow $100 only pay back $99 change the next day.

But why would a lending bank ever agree to a negative interest rate loan?

But barring any regulatory requirement forcing them to keep cash in the system, the simplest explanation for why we might still see activity here is that the cost of holding cash Mayo way the fee of leaving the money with someone else, even if you have to pay them since holding an excessive amount of money could increase security fees, wages and even regulatory costs, it might make sense for a bank to leave the money at another institution.

But banks using the overnight market are borrowing money for less than a day, and the fees may be negligible if banks frequently switch between lending and borrowing as they tend to do.

Whether consumers will be able to borrow at a negative interest rate loan is a different matter.

Firstly, when it comes to consumer loans, commercial banks will always charging interest rate that is higher than what they pay for their own loans.

If they can borrow for 2% will charge you 4%.

And if they can get a loan that pays a 0.5% negative rate, they may still charge you a positive 1.5%.

So while interest rates would fall, they may not necessarily fall into the negative range for consumers.

And in fact, we've already seen it in Denmark.

Not too long ago, a Danish bank was offering a negative 0.5% mortgage mean you could buy a house and eventually pay back less than what it cost you exciting, right?

Well, it shouldn't be well being paid to borrow may sound great.

Actually, we still don't fully understand all the ramifications of negative interest rates.

Negative interest rates would boost spending.

Investing in lending, which in turn would cause inflation, inflation or rising prices would mean the value of the dollar falls, which would make US goods cheaper to foreign countries.

Providing another boost to demand for goods and service is these are all things that should increase business activity, employment, wages, all that good stuff.

Indeed, we've seen negative interest rates imposed by the eurozone, Denmark and Japan, among other countries.

But these places struggled with chronically slow growth in deflation.

When prices fall, deflation could be bad as it encourages banks and consumers to hoard their money rather than spend it.

Since the dollar tomorrow, we worth more than a dollar today.

This can lead to a vicious cycle and prompt ferga declines in spending and Maur deflation.

So negative interest rates were seen as a way of discouraging this an encouraging spending, and yet these places still experience low inflation and slow growth.

On top of this, there are a number of ways in which negative rates could backfire.

Negative rates could cause a run on the banks of people up to physically store their cash, rather than keeping it at the banks and paying a fee for it.

We could also see runaway inflation and even an asset bubble.

If mortgages offered negative rates, people may begin buying up housing prices toe unsustainable levels, so it might not even be easier for you to afford a house.

Negative rates would also hurt savers and income investors, as it would mean receiving a low to no yield on bonds or other income instruments.

In other words, those with low risk tolerance is maybe force into risk your positions just to maintain their wealth.

Negative rates would also squeeze profit margins for the banks, since again they will need to pay for their deposits at the central bank.

And interestingly enough, some research suggests that this has actually decreased London activity in countries that implemented negative rates since it hurt the banking profits and discouraged London activity as a whole.

But one of the more certain consequences of implementing negative rates now is that it would take away an important lever for the central bank in an actual downturn.

S s high inflation is close to target, and earnings growth, while it is slowing, is still healthy.

Certainly not the scene face by the eurozone, Denmark and Japan.

Yes, we may see a recession, but there are no indicators of a pending crisis.

Were to implement such a drastic measure as negative interest rates to boost the economy and then later experience something like the 2008 housing bubble, the interest rate tool would be largely spent.

Debt would be even higher than what it currently is it we could be in for a disaster, so that's a controversial and paradoxical negative interest, rate explained.

It's something we still don't fully understand, given the small sample size of countries implementing it and the mere decades worth of data.

Sure, as Trump tweeted, low interest rates may allow the U.

Government to refinance at a lower rate, but even that may not pay note as expected.

Germany, a country with negative rates, was recently unsuccessful and raising two billion euros worth of its negative yield government bonds on Lee, raising 824 million At the end of the day, Monetary policy can only do so much in negative rates should be treated as the dangerous and desperate tool it is.

After all, there is no free lunch in the world of economics, and the potential hit to the integrity of the U.

Dollar, the economy and, of course, the independence of the Federal Reserve may all well outweigh the benefits of a negative interest rate shift.