The end of negative interest rates

It finally seems to have come to an end. The cases when interest rates dip below 0%, negative interest rates. This could happen during periods of deflation as the value of a nation’s currency rises because of a drop in prices, resulting in the central bank setting interest rates into negative territory.

So, in effect interest is paid to borrowers rather than to lenders. Central banks typically charge commercial banks on their reserves as a form of non-traditional expansionary monetary policy, rather than crediting them. This tool is meant to encourage lending, spending, and investment rather than hoarding cash, which will lose value to negative deposit rates.

Economists have still not been able to decide if negative interest rates are an effective monetary tool in achieving the goal in the countries that established it and in the way it was intended. It is also unclear whether negative interest rates have successfully spread beyond excess cash reserves in the banking system to other parts of the economy.

Central banks in the Eurozone, Switzerland, Scandinavia, and Japan implemented negative rates, intended to spur economic growth through spending and investment. Depositors would be incentivized to spend cash rather than store it in the bank and incur a guaranteed loss. Savers would have to pay interest instead of receiving it. By the same token, borrowers would be paid to do so instead of paying their lender.

Therefore, it would incentivize many to borrow more and larger sums of money and to forgo saving in favor of consumption or investment. If they did save, they would save their cash in a safe or under the mattress, rather than pay interest to a bank for depositing it.  

The experiment with negative interest rates ended in March in Japan without having accomplished much of anything, despite a 12-year negative interest rate period. Outside of the central banks that pushed the idea as a solution to stagnant growth, few people were persuaded. Wall Street did not like it and ordinary people certainly never got comfortable with the idea of being paid to borrow and charged to save money.

At the peak of the negative experience, about $18 trillion in bonds had negative yields, but actually making individuals pay to leave money in the bank has always been tricky. Better to keep it at home then. Radical economists want to take the negative interest rates to the next step and get rid of paper currency altogether. This would mean more control of the whereabouts of the money as it can’t be under the mattress.

With actual interest rates around zero for much of the past 16 years, demand boomed, especially outside the U.S., for $100 bills, the easiest denomination to store but the hardest one to spend. There are now more of them in existence than ubiquitous $1 bills.

The response to future financial crisis could well be negative interest rates again, even in the U.S. During the Great Depression, monetary policies did not revive the economy, so in the end, the government simply gave people money to spend. The same method was used when American rates were cut to zero during the Covid pandemic in 2020 and the government sent out checks to people to fuel spending. However, in the U.S., the Biden administration flooded the country with money and went on an out-of-control government spending spree. As a result, inflation surged to a 40-year high, which eventually made the Fed increase interest rates. Given the enormous amount of government money, in the trillions, the economy will take time to recover and find a healthy equilibrium again.

At the same time, it seems that the global experience with negative interest rates has come to an end. This is likely a positive sign for the global economy, but given the volatility and uncertainty in the macroeconomy, it would not be surprising if it comes back at some point again. It is probably even a safe bet.