A quick run-up on the concepts and applications of sub-zero interest rates.
Everything else being constant, nominal interest rates are the ones that guide consumers and the economy to spend, save or invest. What if these interest rates become negative? Does that mean that borrowers are paid and savers lose money? Should the ideal situation not be the opposite of this? Let us examine such a situation and its implications.
Interest rates in an economy drive the purchasing power of its citizens. Purchasing power depends on interest rates, and many factors demand and supply of the particular products and/or services in question, and nonetheless, inflation. In 2013, when the Federal Reserve contemplated a negative interest policy, the target was also to reduce or to maintain unemployment rate to less than 7.5 percent.Infact, the Federal Reserve Act states its three goals explicitly – “maximum employment”, “stable prices” and “moderate long-term interest rates”.
The 2007-08 financial crisis brought about some aggressive, and some unusual monetary policies, by economies. While the US reduced its benchmarks interest rate to fall within the range of 0.0 to 0.25 percent, Europe for one, cut its interest rates in 2014, and what prevailed were negative interest rates. The year of 2016 has already witnessed a little over 500 million people experiencing such interest rates. On the face of it, a negative interest rate policy should drive corporates and business houses to seek more loans. Such a policy renders boosting of the economy in terms of not just innovation and number of businesses, but also in terms of flow of money and rate of employment. However, the other facade of such low interest rates is decreasing income to the banks, customers of banks withdrawing their savings, and the banks, consequentially, suffering with substantial losses from such costs. Next in line are the losses on scrips of these banks in the domestic stock market and then the international stock markets. European and global equity markets have been victims of the same. Forex markets are the ones inevitably to get affected next. While lower interest rates on a currency may attract exports for now, attractive interest rates (read positive) may take the cakein the long term. Economic growth is likely to be affected in the long run, and the central banks of countries generally reverse this scenario by increasing the benchmark interest rates, and therefore controlling inflation at a certain percentage. The plan is to revive the economy to a certain extent.