What Are Negative Interest Rates?
Negative interest rates refer to the case when cash deposits incur a charge for storage at a bank, rather than receiving interest income. Instead of receiving money on deposits in the form of interest, depositors must pay regularly to keep their money with the bank. This environment is intended to incentivize banks to lend money more freely.
How Does a Negative Interest Rate Work?
While real interest rates can be effectively negative if inflation exceeds the nominal interest rate, the nominal interest rate had been theoretically bounded by zero. Negative interest rates are often the result of a desperate and critical effort to boost economic growth through financial means.
Negative interest rates may occur during deflationary periods when people and businesses hold too much money instead of spending. This can result in a sharp decline in demand, and send prices even lower. Often, a loose monetary policy is used to deal with this type of situation. However, with strong signs of deflation still a factor, simply cutting the central bank's interest rate to zero may not be sufficient enough to stimulate growth in credit and lending.
Real World Example of a Negative Interest Rate
In recent years, central banks in Europe, Scandinavia and Japan have implemented a negative interest rate policy (NIRP) on excess bank reserves in the financial system. This unorthodox monetary policy tool is designed to spur economic growth through spending and investment as depositors would be incentivized to spend cash rather than hoard it and incur a guaranteed loss.
It's still not clear if this policy worked in the way it was intended, and whether negative rates successfully spread beyond excess cash reserves in the banking system to other parts of the economy.