Negative Interest Rates Explained

The federal interest rate is a tool that the Federal Reserve can use, in order to stimulate lending and investing to speed up the economy. This has often been a tool that is utilized to fight things like GDP contractions and recessions. The issue, however, is that zero is often regarded as the lowest threshold for the interest rate. However, if the interest rate is already set low, then what does the Federal Reserve do to counteract any other possible slowdowns. This exact situation is what has led discussions of negative interest rates back into the national conversation. What exactly are negative interest rates, though? And are they really, realistic? Find out more…

Meant to incentivize velocity

Interest rates refer to how much money is made when it is sitting in banks and bonds. A low interest rate means that these types of accounts don’t yield as much of a return, and so it incentivizes people to spend and invest, thus stimulating the economy. Negative interest rates take this to another level, though, because the money in the central bank will be charged as it is kept in there. Essentially, people will be paying the banks for the privilege of holding their money. This might seem counterintuitive to everything that these financial institutions are supposed to represent, but the has its benefits. Namely, people will be far less likely to let their money sit in an account when it is slightly being drained, instead of growing. This causes people to invest their money in higher amounts, which increases the velocity of currency, so that the entire economy can lift up.

Why people thought negative interest rates were impossible

People have been saying that the concept of negative interest rates in the United States were unthinkable. In theory, the idea is that cash and physical currency will always be able to retain its value, so consumers would just hold onto their money. However, this doesn’t seem to be the case in the modern world. We know this because several countries have already enacted negative interest rates with some success, for a time. This includes Sweden and Denmark, who have used negative interest rates in 2010 and 2012, respectively, to increase the money flow in their economies.

Fed is considering using negative interest rates

The Federal Reserve is currently strongly considering the use of negative interest rate policy in the United States. However, it may be unlikely to happen in this country, as the implementation would be complex with how large the United States money market is. Janet Yellen, indeed, has already says she is not sure, yet, of what the implications might be.