Learn about negative interest rates and their impact on the economy

Learn about negative interest rates and their impact on the economy

Author: Michael view: 32 Update: 14/11/2023 Downloads: 0

Negative interest rates are a fairly new concept to many people. According to the definition of the European Central Bank (ECB), negative interest rate is an interest rate that depositors must pay to banks to keep money in their accounts. This means that, instead of receiving interest for depositing money, depositors will have to pay money to the bank.

Negative interest rates are applied to stimulate the economy during a recession. When interest rates are positive, people tend to keep money in banks because they can receive interest. This leads to a shortage of capital for investment and consumption, causing the economy to stagnate. On the contrary, when interest rates are negative, people tend to spend and invest more because they do not want their money to lose value due to inflation.

What are negative interest rates?

Learn about negative interest rates and their impact on the economy

Negative interest rates are defined as interest rates below 0%. This means depositors will have to pay the bank for depositing money instead of receiving interest. Currently, negative interest rates have been applied in many countries around the world such as Japan, Sweden, Switzerland and Europe.

However, negative interest rates are not a completely new concept. In the past, central banks have applied negative interest rates during periods of economic crisis to stimulate the economy. However, the application of negative interest rates has become more common in recent years as many countries are facing serious economic challenges.

The mechanism of negative interest rates

To better understand how negative interest rates work, we need to learn about how central banks manage money. The central bank is responsible for adjusting interest rates to influence the operations of commercial banks and the economy.

When the central bank applies negative interest rates, commercial banks will have to pay the central bank when depositing money. This reduces the profits of commercial banks and encourages them to lend money at lower interest rates to attract customers. This will lead to a reduction in lending interest rates in the market and encourage people to spend and invest more.

Why are there negative interest rates?

Learn about negative interest rates and their impact on the economy

Negative interest rates are often applied in the following cases:

Inflation is low or negative

When inflation is low or negative, people tend to keep money in banks because they don’t want their money to lose value. This leads to a shortage of capital for investment and consumption, causing the economy to stagnate.

To encourage people to spend and invest more, central banks often apply negative interest rates to reduce the value of money in bank accounts and encourage people to use cash or invest in loans. Investments have higher liquidity.

Economic depression

When the economy declines, consumer demand and investment decline. This leads to excess capital in the economy. To stimulate the economy, central banks often apply negative interest rates to encourage people to spend and invest more.

Asset bubble

When an asset bubble occurs, asset prices increase unsustainably. This can lead to inflation and affect the economy. To contain asset bubbles, central banks can apply negative interest rates to reduce the value of money in accounts and encourage people to spend and invest in other investments.

Negative interest rates in the US and other countries

Learn about negative interest rates and their impact on the economy

Currently, negative interest rates have been applied in many countries around the world such as Japan, Sweden, Switzerland and Europe. However, the US has never applied negative interest rates in its history.

Meanwhile, Europe has applied negative interest rates since 2014 and currently there are more than 20 European countries applying negative interest rates. Among these, Sweden and Switzerland are the two countries with the highest negative interest rates, -1.25% and -0.75% respectively.

However, the application of negative interest rates also faces many controversies. Many experts believe that applying negative interest rates can cause negative impacts on the economy and banking system.

Negative interest rates and their impact on the economy

Negative interest rates can have positive and negative effects on the economy. Below are the main effects of negative interest rates on the economy.

The positive effects of negative interest rates

  • Stimulate spending and investment: With negative interest rates, people will tend to spend and invest more to avoid depreciation due to inflation. This will help stimulate economic activity and increase production.
  • Debt reduction: With negative interest rates, loans will have lower interest rates, helping to reduce the debt burden for people and businesses.
  • Increase asset value: Negative interest rates can increase the value of assets such as real estate and stocks. This can help increase assets for people and businesses.

The risks of applying negative interest rates

  • Impact on bank operations: With negative interest rates, banks will have to pay the central bank for deposits, reducing their profits. This could lead to cuts in operating costs, reducing lending capacity and creating instability in the banking system.
  • Impact on currencies: Negative interest rates can reduce the value of money and create inflation. This can affect people’s living standards and reduce the value of deposits.

Mechanism for calculating negative interest rates

The mechanism for calculating negative interest rates is decided by central banks. Normally, central banks will decide on negative interest rates based on the current economic situation and monetary policy goals.

To calculate negative interest rates, central banks will use indicators such as the inflation rate, economic growth rate and the level of competition in the economy. From there, they will decide on the appropriate negative interest rate to achieve the goal of monetary policy.

Compare negative interest rates and positive interest rates

Negative interest rates and positive interest rates have similarities and differences.

Similarities

Both types of interest rates are fees that borrowers pay lenders for using their money. Both can also be applied in monetary policies to regulate economic activity.

Differences

  • Purpose: Positive interest rates are often applied to curb inflation and maintain price stability, while negative interest rates are often applied to stimulate economic activity.
  • Impact on borrowers: With positive interest rates, borrowers will have to pay higher interest rates, while with negative interest rates, they can benefit from lower interest rates or even pay no interest rates.

Negative interest rates and their role in monetary policy

Negative interest rates play an important role in the monetary policy of central banks. Applying negative interest rates can help central banks achieve goals such as:

  • Stimulate economic activity: Negative interest rates can encourage people to spend and invest more, helping to stimulate economic activity and increase production.
  • Control inflation: With negative interest rates, people will tend to spend and invest more, reducing inflation and maintaining price stability.
  • Support for other monetary policies: Negative interest rates can be used as a support tool for other monetary policies such as loose monetary policy or expansionary monetary policy.

Conclude

Negative interest rates are a new concept and are being applied in many countries around the world. Despite having positive effects on the economy, applying negative interest rates also has risks and faces many controversies. However, with an important role in monetary policy, negative interest rates are still an effective tool for central banks to adjust economic activity.

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