Economists have different opinions regarding the question whether it is possible to earn negative nominal interest rates. Although negative rates are justifiable in certain instances, it is presumed that they are unsustainable. During poor economic performance seasons, negative nominal interest rates are adoptable.
Economists argue that nominal interest rates should not be negative. Although rich central banks have begun imposing negative interest rates, such actions have not been practiced previously. For instance, in 2014, the European Central Bank adopted a -0.1% interest rate on deposits held in its vaults (Benchimol, 2014). Moreover, the bank lowered the rate to -0.2% later during the year. In addition, negative interest rates have been imposed in Switzerland and Denmark as well. Riksbank, Sweden’s central bank, adopted a negative rate in 2015. The justification for the introduction of negative rates is based on the belief that such a move is likely to boost an economy in many ways.
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In periods when an economy is underperforming, it is practical to lower or cut interest rates. For example, during the Great Depression (in the 1930s), the US Treasury’s notes and bonds earned negative nominal interests as they neared their maturity (Benchimol, 2014). Decreasing such rates reduces the attractiveness of saving and borrowing (Goodhart, 2013). In other words, money holders are encouraged to spend rather than save funds. Through spending, recovery is possible since the expenditure kick-starts an economy.
An economy may encounter deflation, a situation where prices are declining. Within the Euro region, the interest rate is 0.05%, but when adjusted to inflation, it constitutes 0.65%. The reason for this is the fall in inflation to -0.6%. When deflation worsens, real interest rates rise further, hence choking recovery efforts instead of supporting them (Benchimol, 2014). In a bid to avoid such a condition, central banks in the European zone have been forced to consider the adoption of negative interest rates.
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One of the assumptions why interest rates cannot be negative rests on the effect of such rates. Economists reckon that negative rates might push consumers to withdraw their savings from banks and keep their money in their houses, which will create a shortage of loanable funds, thus pushing interest rates higher (Blinder, 2012). In addition, negative rates might cause bank-runs, leading to the collapse of the banking system. In addition, economists assume that negative interest rates are likely to generate financial instability in different ways (Blinder, 2012). For instance, banks might object to passing negative rates to customers because of the fear of losing them. Another assumption is that institutions that entirely depend on interest-earning assets would collapse if the rates were to be reduced beyond the zero mark. For instance, building societies in Britain, which depend on such assets as mortgage backed by interest payments, would crumble because of negative interest rates.
It is held that it is impossible to earn or attract negative nominal interest since investors have the option of holding their funds. On this basis, any bond is expected to have a positive return or yield (Goodhart, 2013). The possibility of negative rates of interest calls for an examination of environmental and institutional factors when analyzing financial markets.
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In the past, a number of economists assumed that having negative interest rates was impossible since no investor or depositor would pay a bank to keep their money. Instead, depositors would opt to stack their funds in their houses or invest them in different economic activities. In addition, it was assumed that a move to impose negative interest rates would collapse the banking industry because depositors would opt to withdraw their funds from banks. Although in the past it was almost impossible to have negative interests rates, the phenomenon has become real since some European and Japanese banks have already adopted the policy.