How monetary policy works with negative interest rates


Since the financial and economic crisis, central banks around the world have lowered their interest rates ever lower to help their flagging economies. Some central banks, including the European Central Bank (ECB), the Bank of Japan, the Swiss Central Bank and the central banks of Denmark and Sweden, even cut key rates below zero.

In the following, central arguments are presented as to why monetary authorities are taking negative interest rates and the dangers of such monetary policy are highlighted.

Why do some central banks have negative key figures?

Negative rates mean that banks have to pay interest when they park excess liquidity at their central bank. Therefore, it is often spoken of "penalty interest". Central banks thus punish the financial institutions as they hoard funds. Instead, they should pass them on to the economy in the form of loans. Because that is pushing the economy.

The ECB set its so-called deposit rate below zero for the first time in June 2014 – at that time to minus 0.1 percent. Since then, it has been lowered in several steps ever lower, last Thursday on minus 0.5 percent. The Bank of Japan introduced negative interest rates in January 2016 to curb an unwanted rise in the national currency yen, which weighed on the export-dependent economy. It has since demanded 0.1 percent interest on part of the surplus reserves it parks.

What are the pros and cons?

Economists argue that negative interest rates help keep borrowing costs low in the economy. In addition, negative interest rates should help weaken the currency by making it less attractive to investors than other currencies. A weaker currency, on the other hand, gives a competitive advantage to exports on the world market. In addition, this pushes inflation because import costs are rising.

However, by keeping interest rates low on the market, negative rates also make lending institutions tend to earn less income. If the profits of the financial institutions suffer too much, this could slow down their willingness to lend. In Germany, banks have been complaining for some time that ultra-high rates are gnawing at their earnings. Insurers, on the other hand, are finding it increasingly difficult to meet their customers' guarantee commitments as a result of the long period of low interest rates. Consumer associations also fear that institutions will shift costs more to their customers.

There is also a lower limit, from which a further rate cut makes no economic sense. After all, at a certain point, banks could shift their money into their own vaults in terms of costs. That would undermine monetary policy.

What do central banks do to cushion side effects?

The Bank of Japan has introduced a staggering system to cushion the burden on the institutions. Thus, only a part of the surplus reserves is charged with a negative interest rate of minus 0.1 percent. For the remainder, interest rates of zero percent and even 0.1 percent apply. In Switzerland, too, no penalty is levied on all excess funds parked at the central bank. Here, the allowance is based on the respective minimum reserve of a bank. This is the sum of money that a bank must deposit in any case as a deposit with the central bank. The Swiss franchise amounts to 20 times the respective minimum reserve. In the euro area, there should now be a two-tier system that excludes some of the savings deposits from the penalty interest. (Reuters)

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