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What Negative Interest Rates Would Mean For Your Wallet

May 25th, 2020 12:25 PM by Jackie A. Graves

The U.S. economy is slipping into what could be a severe recession, and the Federal Reserve is taking unprecedented measures to help it survive the consequences of the COVID-19 pandemic.

The Fed stepped in with an emergency rate cut in March. It has injected $2.3 trillion into the economy through emergency initiatives such as buying municipal bonds and lending money to small and mid-size businesses that don’t qualify for Small Business Administration emergency loans. It’s even buying corporate bond ETFs.

These measures show the Fed is doing whatever it takes to prop up the economy. Until now, it had never utilized its authority to purchase municipal bonds or ETFs. But there has been heated debate over a controversial monetary policy tool that’s also at the Fed’s disposal: Negative interest rates. 

They’ve been used by other global central banks, to mixed results. Are negative interest rates really in the cards for the U.S.? If so, what might they mean for your wallet? Here’s what you should know.

What Are Negative Interest Rates?

Interest rates are one of the main levers the Federal Reserve uses to adjust monetary policy and maintain balance in the U.S. economy. The central bank adjusts the federal funds rate to guide how individual banks and lenders determine their own rates. 

The Fed raises interest rates to help cushion the economy against inflation, because higher rates make borrowing by consumers and businesses more expensive. It lowers interest rates when the country is facing a recession because it encourages borrowing and spending, which stimulate the economy. 

So what about negative interest rates? If a central bank implements negative rates, that means interest rates fall below 0%. In theory, negative rates would boost the economy by encouraging consumers and banks to take more risk through borrowing and lending money. 

Negative Interest Rates Fight Deflation

In economic downturns, people typically hold onto their money and wait to see some sort of improvement before they ramp up spending again. As a result, deflation can become entrenched in the economy: People stop spending, demand declines, prices for goods and services fall, and people wait for even lower prices before spending. It’s a pernicious cycle that can be very hard to break.

Negative rates fight deflation by making it more costly to hold onto money, incentivising spending. Theoretically, negative interest rates would make it less appealing to keep cash in the bank; instead of earning interest on savings, depositors could be charged a holding fee by the bank. Simultaneously, negative interest rates would make it more appealing to borrow money, since it would push loan rates to rock-bottom lows.

Negative Interest Rates In Japan and Europe

In 2014, the European Central Bank (ECB) was the first central bank to adopt a negative interest rate policy, to address the eurozone crisis. The ECB lowered its deposit rate to -0.1% that year in an attempt to hold off deflation and move the economic bloc out of a protracted malaise. Today, the current ECB deposit rate is -0.5%, the lowest on record.

The Bank of Japan (BoJ) has been fighting deflation for two decades. It was the first central bank to move to a zero interest policy in 1999, and its key rate has been negative since 2016. Neither the BoJ nor the ECB have been able to move rates back into positive territory.

In Europe, inflation has remained anemic and many argue that consumers have simply responded to negative rates by moving their savings around to banks offering higher yields, even if it’s by a few tenths of a percentage point, as reported by the Wall Street Journal. Some banks report that big depositors are requesting their physical cash be put in vaults where it can avoid the negative interest rates, and businesses have held back on spending and resisted the “temptation of cheap money.” 

One research paper from the ECB found no evidence that negative rates were incentivizing households, corporations and non-bank financial institutions to keep more cash on hand with the intention of pumping it into the economy. Meanwhile, a research paper from the Swedish House of Finance suggests the opposite, stating that the monetary policy remains effective when it’s implemented with measures to make it more costly for hoarding cash. 

Are Negative Interest Rates Coming to the U.S.?

You’ve probably heard some buzz around negative interest rates over recent weeks. President Donald Trump has expressed his interest on Twitter, calling negative interest rates a “gift” for the economy. Investors in future markets have started betting on the Fed implementing them, helping to keep the idea in the headlines.

But the Federal Reserve insists negative interest rates are not on the table.

As of now, the Fed remains adamant against implementing negative rates as a tool to help stabilize the U.S. economy, even assuming they would work as promised. Federal Reserve Chairman Jerome Powell has repeatedly said that negative rates are not something that will be implemented.

“I continue to think, and my colleagues on the Federal Open Market Committee continue to think that negative interest rates is probably not an appropriate or useful policy for us here in the United States,” said Chairman Powell in a recent 60 Minutes interview. “The evidence on whether it helps is quite mixed.”

Joe Brusuelas, chief economist at RSM, believes implementing negative interest rates wouldn’t be an easy task. Plus, he also doubts they would be the best way to help the economy now—although implementing them wouldn’t be an impossible undertaking for the Fed. 

“It’s very difficult to do and it requires some pre-conditions to be set by regulatory agencies and the central bank to make it work,” Brusuelas says. “It’s highly conditional. You’re only going to do this under very specific or quite dire circumstances. This isn’t something that’s going to be turned to just because the bond market is turning to a wavy type recovery.”

How Would Negative Interest Rates Affect You?

Even if negative interest rates remain a very distant possibility, it’s always good to understand how monetary policy can affect your financial situation. Negative interest rates would change a variety of personal finance aspects. Here’s how: 

  • Loans: Europe has seen some remarkable impacts on lending due to negative rates. Denmark’s third-largest lender, Jyske Bank, serviced 10-year loans with a -0.5% annual rate. Nordea Bank, based in Finland, offered 20-year mortgages at 0% interest last year. While that sounds incredible, some analysts warn that extremely low rates on mortgages could drive housing prices higher, since borrowing would become cheaper and thus skyrocket demand.
  • Credit cards: Negative interest rates would certainly depress credit card interest rates. The average credit card rate right now is 16.61%, according to Q1 data from the Federal Reserve. A negative interest rate could pull that lower, but it’s totally unrealistic for anyone to expect to get paid every time they swipe their credit card. 
  • Savings accounts and products: Yields on savings accounts would be crushed by negative interest rates. Remember: One of the main functions of negative interest rates are to encourage spending instead of keeping money tucked away in an account. High-yield savings accounts could become a distant memory. Big savers could be hit hard by negative interest rates, too. In 2019, Jyske Bank launched negative interest rates on customers who held balances over $1.1 million, making them pay 0.6% annually to hold their money in the bank.
Bottom line

Negative interest rates are a monetary policy tool for unprecedented economic times, and some argue they require complementary regulations to make them work. The Federal Reserve has repeatedly said it’s not looking to implement them at this time, but having a general idea of how negative interest rates could potentially affect you in the future is worth making an effort toward.

Source: To view the original article click here

Posted by Jackie A. Graves on May 25th, 2020 12:25 PM


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