The use of negative interest rates monetary policy has taken the European nations by storm, including Japan. Economists have speculated that following the cutting down of the USA interest rates by the Federal Reserve in 2019 after 11 years, negative interest rates are bound to become the next monetary policy to become implemented. However, not very many people understand what negative interest rates mean and their impacts. Scholars, policymakers and economists have supported and opposed the use of negative interest rates. This interview aims at pointing out what negative interest rates mean and what their impact would be for the USA economy if implemented.
Can you first elaborate on what negative interest rates are and what is the history behind the use of negative interest rates?
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It is essential that I first define what an interest rate means. An interest rate is the amount of money that an individual, organization, nation or any other entity pay in addition to borrowed money. A perfect example is seen in the case whereby when one borrows a $200 loan with an annual interest rate of 4%, it is an indication that one will pay back the $200 loan plus a $4 after the one year. One the other hand, in case the interest rate is -4%, it is an indication that the bank will pay the borrower $4 after a year of using the $200
Johnston (2019) states that the main reason for implementing a negative interest rate is to increase and make borrowing easy for people. This is a risky undertaking because the lender is the one who is going to provide the funds and still take the risk for loan default. The negative interest rates are considered as being the last option for the central bank to stimulate economic growth in case it has run out of policy options. I would thus refer to it as an “experimental measure” after traditional policies have proven to be ineffective in stimulating economic growth
The history of interest rates can be linked back to the Swedish central bank back in July 2009 when the bank cut down the interest rates to -0.25% (Johnston, 2019). There have been other European countries, including Japan, which have also opted to use negative interest rates as a means of stimulating the economy. In total, negative interest rates have forced government into debts amounting to over $9.5 trillion as of 2017 since the adoption of this drastic monetary policy (Johnston, 2019).
From your response, I can see you have described the negative interest rates as being “an experimental measure undertaken by central banks”. Then, what would force the central bank to opt for such a policy option?
Currently, four countries have adopted the negative interest rate option, including one currency block by 2019. As of July 2019, the Fed cut the interest rates for the first time in 11 years and from the current trends, the country is headed towards a negative interest policy direction (Graham, 2019). However, to fully understand why a country would opt for negative interest rates as the last option, I will give reasons basing on the four nations and one currency block.
Japan faced an economic stagnation that lasted for over 20 years following the assets bubble that began in 1991 (Graham, 2019). Inflation has affected Japan, and the central bank has implemented various policy action such as quantitative easing, money printing and even low rates to stimulate the economy not all of which seemed to work. Therefore, Japan decided to introduce negative interest rates to fight off ever-increasing inflation. In the case of the Eurozone, it implemented a 2.5 trillion euro assets purchasing program, to stabilize the block banking institutions (Graham, 2019). However, this program led to huge amounts of money being injected into the economy. In 2014, the ECB lowered its interest to -0.1% to stimulate economic growth (Graham, 2019).
As I have earlier indicated, Sweden was the first nation to implement the negative interest rate policies boost its economy (Graham, 2019). Switzerland and Denmark lowered its interest rates to negative to defend their currencies from the global financial turbulence. In 2015, the Switzerland lowered its interest rates to -0.75%, which led to a dampening of CHF foreign demand (Graham, 2019).
It is an indication that the Central banks of the various countries introduced negative interest rates for particular reasons. However, the shocking factor is that it is only Switzerland that has had positive outcomes for introducing this type of policy (graham, 2019). The other nations and currency bloc have continued to witness negative impacts on the economies, which are expected to continue affecting the countries into the future.
Are you saying that negative interest rates can negatively affect the USA economy if the Federal Reserve decided to use it as a monetary policy option? From the current directions of the interest rate in the USA, they have been cut by almost half is that an indication that the USA is headed towards a destructive direction?
Yes, that is what I mean. In case the USA decided to head towards that direction, the country’s economy, including its citizens are going to pay a very high price. In Japan, after introducing negative interest rates to curb inflation public social spending has doubled reaching 22% of the GDP levels as compared to 1991 (Graham, 2019). The government is also not able to invest as huge debts bloat it. In Eurozone, the negative interest rates have led to reduced profit margins and the business model has been put in turmoil (Graham, 2019). In Sweden, the exports have not grown, corporations are hoarding their profits in foreign nations, and it has created housing bubbles. Denmark has also paid the price for having negative interest rates as asset prices have continued to boom and by 2019; they had grown by 4.2%. (Graham, 2019). Denmark has also had a widening inequality gap attributed to negative interest rates and mortgage borrowers have been forced to finance their houses using negative rates.
When you say banking institutions will have a reduced profit margin, how does the negative interest rates contribute to this? Moreover, how is the reduced profitability of banks going to affect the USA economy in general?
The entire globe, more specifically European nations are undergoing a strange economic experiment as countries continue to adopt the negative interest rate monetary policies. As of 2017, the amount of negatively yielding bonds reached an overwhelming figure above $9.5 trillion (Johnston, 2019). It is at this point that we are starting to witness the destructive impacts of the negative interest rates. Under ordinary conditions, the short-term interest rates are controlled by a Central bank as it determines the rates banking institutions will receive on their reserves held by the central bank. All banking institutions get profits from the interest rate differential between borrowing short and lending long. A bank’s profitability is determined by the difference between deposits and lending rates; however, with the introduction of negative interest rates, this difference becomes non-existent (CNBC, 2019; Hess, 2015). These interest rates will force the banking institutions to pay interest on the held reserves. However, they are not given any form of relieving from the interest they have to pay on the client deposits. By forcing banks to pay interest on loans and only receive interest on deposits, it makes the whole profit-making situation to go haywire. The lending activities will suffer as profitability declines, which squeeze their profitability margins (Constable, 2019). The credit is made cheap by the banks and to make matters worse. The borrowers are even paid to take it. Therefore, why would one want to lend money to a borrower if they have to pay you again?
On to your second question on how low profitability margins can affect the economy, the profit received by banks is essential for bank capital, bank soundness and financial stability. Low profits will affect the banks' ability to generate internal capital through retained earnings and thus affecting their ability to offer credit to the economy. The banking institution will not have an ability to supply credit to the real economy and thus underpins economic growth (CNBC, 2019). Small and medium enterprises that are important in any economy and employment heavily rely on loans and thus without bank making any form of profit, the businesses will not access the credit. It is an indication that the negative interest rates negatively affect the economy through hindering economic growth, investment opportunities and can lead to unemployment.
At some point, you stated that the amount of negatively yielding bonds reached an overwhelming figure over $9.5 trillion by 2017 for European countries and Japan. Can you at least explain what you mean by this, and what its impact on the economy would be?
According to The Wall Street Journal (2019), negative yielding bonds refers to bonds that will see the holders losing their money at the point of maturity. The holders are bound to receive less money than that which used in purchasing the bonds. In order to understand what a negative yielding bond is, let us first understand what a regular bond means. Generally, there are mainly two types of bonds, one with coupons and one without. However, either way, a bondholder should expect more money than that which was used to purchase it. A bond with a maturity of 3%, a $100 par value, 0% coupon and price of $90 indicates that the holder should expect $100 after it matures. In case of anther bond with a three year maturity period $100 par value, 5% coupon and price $105 indicates that the holder is eligible to receive a $5 coupon every year and once it matures after three years $105. In case of negative bond with a maturity period of 3 years, $100 par value, 0% coupon and $105 price, once it matures, the holder will receive $100 instead of the $105 used to purchase it.
Europe and Japan are not new to negative yielding bonds resulting from the implementation of negative interest rates (Johnston, 2019). Negative yielding bonds offered have negative effects on other fixed-income securities. The height yielding bonds have also begun offering negative yield yet they are supposed to offer higher yields. This is bound to affect investors had previously purchased the bonds as they will receive lesser money than what was used in purchasing the bonds The Wall Street Journal, 2019). Moreover, this increases the government’s debt as the investment-grade debt is yielding less than zero. This affects economic growth in general. Few investors who opt to purchase negative yielding bonds do so as a security measure as they believe that the future bonds are bound to offer even worse returns.
In Denmark and Sweden, you stated that negative interest rates led to “bubbles in the housing sector”. What is housing bubble? The USA similarly suffered from the housing bubble in 2000; can negative interest rates make the USA economy to suffer the same fate as that of 2000?
The use of negative interest rate monetary policies has led to skyrocketing of house prices in Sweden and Denmark. A housing bubble refers a situation whereby the housing market experiences a manageable but short-term condition of over-valued prices and extensive conjecture. The USA indeed suffered from a housing bubble in the mid-2000s, and this was largely driven by the technology sector. The NASDAQ was largely affected by the housing bubble such that the most valued stocks at the time came crashing down. Investors abandoned the stock market and instead invested in the housing market bringing about a subsequent stock crash. A crash in stock market indicates that the rates of unemployment will increase as companies cut down on job opportunities. The economy is also affected a there is little money for investment and consumer spending is affected. Following the sue of negative interest rates, people will continue to borrow very heavily for financial institutions and use that money to purchase property as they hunt for higher returns (Graham, 2019). This brings about an increase in the demand for property in the face of limited supply the long-term effects of this is a crash of the real estate market and this negatively affects people across all classes.
I want to thank you for your time on giving us an insight on what enforcing a negative interest rate policy would mean for the USA economy. Any closing remarks?
I am also grateful for giving me this opportunity. All I can say is that the USA government should rethink about adopting the negative interest rate. It is evident that out of all nations that have implemented the policy, Switzerland has been the only one that has reaped positive benefits. The other countries are facing major economic turmoil ranging from reduced unemployment rates, housing bubbles, increased negative yielding bonds, reduced investments among others. The negative interest rate policy is an “experimental measure”, and it should be widely be studied to determine its feasibility before its implementation.
References
CNBC. (2019, November 1). What Would Negative Interest Rates Mean For Consumers And The Economy? YouTube . Retrieved from https://www.youtube.com/watch?v=FiYTmTHFa9E&feature=youtu.be
Constable, S. (2019, January 31). The Unintended Consequences of Central Bank Policies & Negative Interest Rates. Forbes. Retrieved from https://www.forbes.com/sites/simonconstable/2019/01/31/the-unintended-consequences-of-central-bank-policies-part-2-of-2/#272496fc6153
Graham, A. (2019, August 28). Analyzing the Effects of Negative Interest Rates across Five Economies. Topta l. Retrieved from https://www.toptal.com/finance/market-research-analysts/effects-of-negative-interest-rates
Hess, M. (2015, March 30). The serious consequence of the negative interest rates. Swiss Banking . Retrieved from https://www.swissbanking.org/en/services/insight/1.15/the-serious-consequences-of-the-negative-interest-rates
Johnston, M. (2019, July 29). How negative interest rates work. Investopedia . Retrieved from https://www.investopedia.com/articles/investing/070915/how-negative-interest-rates-work.asp
The Wall Street Journal. (2019, September 17). How Negative Yields Work. YouTube . Retrieved from https://www.youtube.com/watch?v=eyBZWrp9P4U&feature=youtu.be
