Why And What Are Negative Interest Rates?

You may have been hearing about negative interest rates and wondering what they are and why they are being used. Normally interest rates are above zero so that if you save money you make money and if you borrow money you pay interest to the bank on your loan. Negative interest rates do just the opposite. People must pay the bank to keep their money and the bank must pay the borrower interest on their loans.

What Are Negative Interest Rates?

Let's say normally the interest rate is 2%. If you had a savings account you would make 2% interest on that account while if you took out a loan you would pay 2% or more interest to the bank. When interest rates drop below zero as they have in Sweden, some countries in Europe, and Japan, just the opposite happens. Currently the rate at the European Central Bank is -.40% and in Japan the rate is -.10%.

Why Are Countries Adopting Negative Interest Rates?

Negative interest rates are adopted to stimulate the economy . They are a last resort when other measures have failed. As businesses and people hold onto their cash and wait for an economic upturn, the lack of spending can cause further economic downturn. If central banks charge local banks money to store their reserves, the idea is that the local banks will want to lend more money, stimulating the economy. Since banks are hesitant to pass on these cost to their consumers, many are absorbing the costs, which decreases their profits. This could actually make them want to lend less, not more.

Another reason countries are adopting negative interest rates is to stabilize currencies. Investors will shy away from taking on European debt which will weaken demand for the Euro. The idea is that this will stimulate exports and therefore increase business and stimulate the economy.

Negative interest rates may work in the opposite direction by negatively affect pensions and retirement funds as well as other long-term investments. They may also cause people to lose confidence in the central banking system and to withdraw their money and invest it elsewhere. Time will tell if the effects of negative interest rates are positive or negative.