• Brent D Dickerson CFP® EA

Negative Interest Rate Policy

Photo by Jomar on Unsplash

I’ve spent way too much of my life in school, and I have the student loans to prove it. But in all that time, there is one concept of economics that was never mentioned, or if it was mentioned it was brushed off as an anomalous event that didn’t require much time in understanding. This abnormal economic concept is a Negative Interest Rate Policy (NIRP). Negative interest rates are so bizarre they are inconceivable by most people, including myself.

We always think in terms of positive interest rates. You go to the bank to borrow money, you pay the loan back with interest accrued. Simple, straight-forward, not much thinking about it. But what if the rate is negative? Does the bank pay you take the loan? Does that mean that you pay back less than you borrowed? Well, not quite – although that may work better than what really happens with NIRPs.

The European Central Bank (ECB) and the Bank of Japan have instituted negative interest rates as a last-ditch effort (and I mean last-ditch!) to stimulate their economies. The economic theory behind negative interest rates is that you make it less attractive for banks, and ultimately their customers, to hold on to cash. Banks make money by lending out the money customers deposit with the banks. So, if you strip away their incentive to hold onto cash, by “charging” them for deposits on their reserves at the central bank, the notion is that they will lend the money out in hopes that they will not have to pay interest on their reserve deposits.

In reality, however, things are quite different from theory, and trying to get an economist to understand the difference between theory and reality is like trying to get a rock to understand anything. The only thing negative interest rates really end up doing is to act as a tax on the banks. Two things come into play here with a tax on business. First, businesses don’t pay taxes they pass the cost of the tax onto others – either customers (through higher costs,) employees (through lower wages or fewer employees,) or owners (through lowered revenues, i.e. dividends.) Secondly, taxes are NEVER stimulative. Taxes are used to create revenue for the government, as well as, spur and hamper economic growth.

So, if a bank is charged, by the central bank, for deposits, and these deposits work as a tax some things are going to happen. First, the bank isn’t going to pay the tax, they are going to pass it onto the customers, the employees, and the owners/shareholders. What has been typically seen is that the banks continue to hoard their money while increasing fees charged to customers – most notably by charging them on their deposits. Thus, if a bank charges its customers to deposit money the customer is going to forego depositing. If a customer doesn’t deposit money then the bank can’t make loans. If a bank cannot make loans economic activity comes to a stop because people are unable to buy things on credit, get mortgages, buy cars, go to school (although that is a government activity these days) and the opposite of what is supposed to happen does happen.

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