Negative interest rates? Really? When you first come across the term, you will be thinking that such a thing does not exist and even if it did you would be wondering as to why it would ever be in use. Or maybe it was just me. And even if it was ever in use, did it actually make sense to put them in practice? Negative interest rates refer to a situation where in the cash deposits at the bank will incur a charge on them. In other words, instead of receiving money on these deposits you have to pay a certain amount extra in order to keep your money. Effectively, they are the opposite of interest rates.Why is this done?  This is primarily so that banks will lend more money to the people and businesses so that they invest in something riskier or spend their money so as to accelerate economic growth in order to avoid a deflationary period. Most of the developed countries have maintained very low interest rates, and whenever a crisis comes up the first action to be done is to cut interest rates. As more problems occur, in order to stimulate growth in the economy they further cut the interest rates till it reaches zero. But say that these actions did not have the intended effect, and the economy is still not at a desirable position. In such a situation, economists face a problem called Zero Lower Bound.Now they have no other alternative other than to plunge into negative interest rates. Diving deeper into the topic so as to get a better understanding as to exactly how negative interest rates, let us consider an example. Suppose you borrow $100 from the bank and say the interest rates are at negative 1%. When you pay back the loan after a year or at the end of the required time period, you will have to pay back only $99. Simple enough right. And isn’t it beneficial to the average customers as well?

1. These rates are meant for other types of borrowing,and the advantage will only be enjoyed by corporate and big banks(Interbank lending,where big banks borrow from each other huge amounts of money even for short periods of time). Even banks in order to maintain reserve with themselves will have to pay an interest to the central bank. Individuals do not benefit as only the base rate(minimum rate) will be negative. Those who can borrow close to the base rate will benefit while individual consumers will be charged more than the market rate. If the interest rates are at -1%, then they will be able to borrow maybe at 1%. Also the deposits they keep with bank will incur a negative interest rates, and thus in order to keep their funds with the bank , they will have to pay more contrary to the one where they receive interest on their deposits. As a whole, the individual consumers will be affected adversely, and as a result they will not want to keep their money with the banks, but will hoard it with themselves and save more, which is the opposite effect that negative rates intended to have on the economy.

If familiar with the Paradox of Thrift you will understand the implications of increase in the amount of savings on the economy. If not, here it is in simple terms: if people in an economy save more, the total savings of the economy does not increase; it will either fall or, at best, remain unchanged. Consequently, the rate of economic growth will be adversely affected if more people don’t spend. Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices. -Warren Buffet During periods when the economy is facing a downturn, central banks often lower the rates in order to stimulate growth, as can be seen in the rates cuts by the Reserve Bank of India(RBI). Due to the recent trade war rage, many countries in Asia like Thailand have also responded aggressively by cutting down rates. And many central banks of various banks all around the world are also contemplating whether or not to go negative. All of this is a reflection of the worry and unexpectedness people are facing due to the worldwide economic slowdown that is being faced at the moment.   Negative interest rate is rather a very unconventional and controversial tool used as dire measure to see an elevation in the economic growth of the country which is employing it.  A close look into Japan and Europe- where negative rates are in use- which will show that the intended results are far from desirable, and mixed at best. Negative rates first came into play when the European Central Bank (ECB) decided to implement it, as a result of which commercial banks holding deposits with the ECB had to pay  interest to them for holding their deposits. Soon after, Bank of Japan(BOJ) adopted the same policy.Negative interest rates were announced by the Bank of Japan(BOJ) in 2016  so as to increase inflation.  But contrarily, inflation expectations fell. According to a research paper published by San Francisco Federal Bank, “the reaction stresses the uncertainty surrounding the effectiveness of negative policy rates as expansionary tools when inflation expectations are anchored at low levels.”And as a result, the economies did not experience any significant growth.These facts call into question the wisdom of Negative Interest Rate Policy.  However, the central banks have argued that had it not been for their interventions the economy would be in a far worse off situation and would have been pulled into a deflationary spiral. A reason that the negative interest policy did not work efficiently in these regions is probably because the central banks would have to cut the rates further in order to get the economy back on track.  The rate cuts were very minimal when we compare the rate cuts implemented by the US from 6% to 1% in 2001. Besides easing the cost of borrowing, people who are in favor of negative interest rates argue that it helps to weaken the currency and thus helps in increasing the exports and boosts inflation by increasing the import costs .  And this is one of the reasons why Donald Trump has been pushing for negative interest rates in recent times, not looking at the degree of uncertainty that such a policy brings with it. He recently called the Federal Reserves as “boneheads” and pushed for negative interest rates. However, an adverse implication of this is that banks will receive a reduced margin( difference between the interest earned from loans and interest paid on deposits. A negative interest rate policy would decrease the margin , and make it difficult for banks to make money, and will actually make them want to lend less. The very existence of such an unconventional policy would generate a level of uncertainty in the minds of the corporates , making them rethinking their decision to borrow and spend. Another effect it can have is  cause a huge unnecessary rise in inflation, and possibly lead to asset bubbles. To date these rates have failed to bring in economic growth and inflation objectives. Negative rates can said to be a disaster in the coming, slow as it may be, but in the end destroying the banking system.   Considering all the uncertainty involved with a Negative Interest Rate Policy, it maynot seem to be such a ‘’boneheaded’’ move if the policymakers did not go ahead with it, right?