Negative Interest Rate Definition

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What are negative interest rates?

Negative interest rates refer to a scenario in which cash deposits result in storage costs in a bank, rather than receiving interest income. Instead of receiving money on interest deposits, depositors have to pay regularly to keep their money in the bank. This environment aims to encourage banks to lend money more freely.

Key points to remember

  • With negative interest rates, cash deposited in a bank generates storage costs, rather than the possibility of earning interest.
  • Negative interest rates can be observed during deflationary times when people or institutions are inclined to accumulate money rather than spend or lend it.
  • The negative interest rate is supposed to encourage banks to make loans during a period when they prefer to hold on to funds.

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 was theoretically limited to zero. Negative interest rates are often the result of a desperate and critical effort to stimulate economic growth through financial means.

Negative interest rates can arise during deflationary times when individuals and businesses hold too much money instead of spending. This can lead to a big drop in demand and send prices even lower. Often, flexible monetary policy is used to deal with this type of situation. However, with strong signs of deflation still a factor, simply reducing the central bank’s interest rate to zero may not be enough to stimulate growth in credit and lending.

In a negative interest rate environment, an entire economic area is affected because the nominal interest rate falls below zero and banks and other businesses have to pay to store their funds at the central bank, rather than earn money. interests.

Understanding a negative interest rate environment

A negative interest rate environment is in effect when the nominal interest rate drops below zero percent for a specific economic area, which means that banks and other financial companies would have to pay to keep their excess reserves stored at the central bank rather than receiving positive interest income.

A negative interest rate policy (NIRP) is an unusual monetary policy tool in which nominal target interest rates are set with a negative value, below the theoretical lower limit of zero percent.

Real 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 banks’ excess reserves in the financial system. This unorthodox monetary policy tool is designed to stimulate economic growth through spending and investment, as depositors would be incentivized to spend money instead of storing it in the bank and incurring a guaranteed loss.

It remains unclear whether this policy has worked in these countries as expected, and whether negative rates have successfully spread beyond the excess liquidity reserves of the banking system to other parts of the economy.

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