How Do Negative Interest Rates Work?

Despite the paradoxical concept of negative interest rates, some central banks adopt this policy tool to boost economic activity and combat deflation, and the Bank of Japan is the most well-known example. But there are others as well, such as the Bank of Denmark in 2012, The Swiss National Bank in 2015, the European Central Bank in 2014, and the Swedish Riksbank in 2015.  In this article, we will briefly explain the concept of negative interest rate and its possible implications.


A Negative Interest Rate Policy (NIRP) implies that the Central Bank charges commercial banks for holding excess reserves to encourage banks to lend and hoard less cash.  In simple terms, under a negative interest rate, it would be expensive to hold cash, so individuals would be encouraged to spend and consume, leading the inflation rate to rise. It’s a double-edged sword which has its pros and cons.


Negative interest rate policies incentivize individuals to spend and invest more, rather than saving in order to drive the economy forward. Nevertheless, it could lead investors to move their money to other countries with higher returns, potentially leading the local currency to depreciate.


Still, currency depreciation is not necessarily bad for the economy as it indicates cheaper exports; making the economy more competitive in the global market. Additionally, extended negative interest rate periods can skew economic activity, fuel asset bubbles, reduce banks' profitability, and undermine consumer confidence.


Negative interest rates are an unusual monetary policy tool that central banks use to promote lending and spending, bolster the economy, and combat deflation. Their effectiveness and possible hazards must be carefully assessed and monitored by policymakers, despite the fact that they have the ability to affect borrowers, savers, exchange rates, and investment decisions.





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