There is a growing debate in financial circles over whether the U.S. Federal Reserve should move to a negative interest rate policy in an effort to stimulate the economy during the coronavirus crisis. Even President Trump has said more than once that he favors negative interest rates and considers them a “gift.”
Yet Federal Reserve Chairman Jerome Powell has recently said that he and his fellow members on the Fed Open Market Committee do not believe negative rates are a good idea for the U.S. He made it clear the FOMC has no plans to pursue such a policy, despite the fact that Japan and much of Europe have had negative interest rates for several years (with questionable results).
Fed Moves Aggressively to Rescue Economy
Most forecasters agree the U.S. economy is now in a severe recession, perhaps the worst since the Great Depression. In response, the Federal Reserve has taken unprecedented measures to help it survive the consequences of the COVID-19 pandemic.
The Fed effectively cut short-term interest rates to zero (00.0%-0.25%) in March. It has since injected $2.5-$3 trillion into the economy through emergency initiatives such as buying municipal bonds and lending money to small and mid-sized 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 everything in its power to prop-up the economy. Until now, the Fed had never utilized its authority to purchase municipal bonds or ETFs. But it remains to be seen if these unprecedented policies will be enough. As a result, discussions about negative interest rates, a controversial monetary policy tool, are growing rapidly.
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 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.
Historically, when you take out a loan, you pay more than the amount originally borrowed because of the interest accrued. Yet if interest rates are negative, the process reverses itself. Think of it this way: If you take out a loan at a negative interest rate, you don’t pay interest on the amount you borrow. Instead, the lender would pay you. With negative interest rates, you’d end up paying back less than you borrowed, so you’d earn money in the long run.
The opposite is true for money you hold in bank accounts or even money market funds. If short-term rates dropped below zero, you wouldn’t earn interest at your bank – you’d actually pay a fee to keep your money in the bank. This fee might be relatively small initially, but in Europe the average fee has climbed to 0.5%. Ouch!
Charging people to keep cash in the bank is meant to encourage people to spend their money, which puts dollars back into the economy. Negative interest rates, in theory, would encourage people to buy homes, use credit cards and take out other types of loans. By spending more, people would be helping the U.S economy.
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 slow spending, demand declines for goods and services and people wait for even lower prices before spending. It can turn into a vicious cycle that can be very hard to break.
Negative rates fight deflation by making it more costly to hold onto money, thus incentivizing spending. Simultaneously, negative interest rates would make it more appealing to borrow money, since the bank is paying you to do so.
Negative Interest Rates in Japan and Europe
So, how have negative rates affected Japan and Europe? The Bank of Japan (BoJ) has been fighting economic malaise for two decades. It was the first central bank to move to a zero-interest rate policy (ZIRP) in 1999, and it held its key rate at zero through 2015. In 2016, however, the BoJ finally dropped its key rate into negative territory and has remained negative ever since.
Actually, the European Central Bank (ECB) was the first central bank to adopt a negative interest rate policy in 2014 to address the Eurozone crisis. The ECB lowered its deposit rate to -0.1% that year in an attempt to lift the economy out of a protracted recession. As noted above, the current ECB deposit rate is -0.5%, the lowest on record.
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. Some banks report that big depositors have requested their physical cash be put in vaults where it can avoid the negative interest rates.
Hoarding of cash is one of the biggest risks of negative interest rates. After all, why pay a bank a fee to hold your money? Why not take your money out of the bank and store elsewhere such as a safety deposit box or under the proverbial mattress? Yet removing a large amount of cash from circulation is bad for the economy. As a result, central banks in Europe have implemented measures to make it more difficult to hoard cash.
Thus far, negative interest rates have not worked nearly as well in Japan and Europe as was hoped, and that was before the coronavirus pandemic struck. While reports are that deaths from COVID-19 are trending lower, the European Commission forecasted earlier this month that Europe’s economy is expected to contract by 7.4% this year, the worst since WWII. Many fear the 27-nation European Union will cease to exist before this crisis is over.
Are Negative Interest Rates Coming to the U.S?
You’ve probably heard some buzz about negative interest rates in recent weeks. As noted above, President Trump has expressed his interest on Twitter, calling negative interest rates a “gift” for the economy. Investors in the futures markets have started betting on the Fed implementing them, helping to keep the idea in the headlines. But as noted earlier, Fed Chairman Powell disagrees and cautioned earlier this month on 60 Minutes:
“I continue to think, and my colleagues on the Federal Open Market Committee continue to think that negative interest rates are probably not an appropriate or useful policy for us here in the United States. The evidence on whether it helps is quite mixed.”
RSM International, a global accounting consortium, believes implementing negative interest rates in the US wouldn’t be an easy task – especially considering the hoarding money risk and other difficulties negative rates would include. Plus, it also doubts they would be the best way to help the economy now.
How Negative Interest Rates Would 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 above 16%, 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: Yields on savings accounts would be crushed by negative interest rates. Remember one of the main functions of negative interest rates is to encourage spending instead of keeping money stashed away in a bank or money market account. Forget high-yield savings accounts. 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 million, making them pay 0.6% annually to hold their money in the bank.
The bottom line: Negative interest rates are a monetary policy tool for unprecedented economic times, and most agree they require detailed complementary regulations to make them work – if they work at all. The Federal Reserve has repeatedly said it’s not looking to implement them at this time, but the pressure is growing.
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com.