The economic talk of the town here in the US has been all about rising interest rates. When they’ll go up, why they might rise slowly, how the election could impact rates, and so on. After years of no rate movement, increased rates are seen as a sign that we’re on the way back to normal. But in other parts of the world, the talk is about negative rates.

Not only are rates falling while ours tries to climb, but in a few 1st world countries interest rates are already negative. But what does that mean?


source: tradingeconomics.com

This is an interest rate that’s negative. And in Sweden it basically represents the base rate for the country. But with negative rates there’s a mental shift in the accounting of such a loan. Imagine for a minute that this was the rate banks were offering you for your savings. At brick-and-mortar banks you can hope for maybe 0.25% these days. Online banks a bit more, 1.00% if you’re lucky. But what if the rate was -0.25%? What does that look like?

Savings ($5,000) 0.25% -0.25%
Balance After 1 Year  $5,013  $4,988

That’s right. Negative rates mean the bank would be charging you to keep your money there.  That’s arguably the right call, if your money is safer in a bank than it is under your mattress.  However, that’s a mental adjustment that the typical consumer is just not ready to make.  Charging negative interest on you and me could spark bank runs, which can send the whole financial system into a downward spiral.

Central banks and governments don’t want that.  So those negative rates aren’t being passed on to regular deposits except in a few situations.  But loans are another animal.  While not as common here in the US, many borrowers in other countries have adjustable rate loans.  Those rates can go up, or down.  When rates turn negative some interesting things can happen:

Hans Peter Christensen got some unusual news when he opened his most recent mortgage statement. His quarterly interest payment was negative 249 Danish kroner.
 
Instead of paying interest on the loan he got a decade ago to buy a house in this northern Denmark city, his bank paid him the equivalent of $38 in interest for the quarter. As of Dec. 31, his mortgage rate, excluding fees, stood at negative 0.0562%.

 While this sounds fun the economics of such a situation are more concerning.  One of the reasons for low interest rates is to encourage borrowing and spending over saving.  This is one of many tools used to stimulate a stagnant economy.  And it does work:

In 2013, pooling money with three other investors, Mr. Christensen bought 10 small apartments for 9.7 million Danish kroner, borrowing 8 million of the amount. The mortgage rate wasn’t negative but was low enough to be attractive.
 
Such investments are rekindling an Aalborg housing market that went into a deep freeze after the 2008 crisis. “People feel that they have to use the money because it is so cheap,” said Michael Soebygge, deputy manager of a local branch of Nordjyske Bank.
 
Mr. Soebygge thinks some household investors may be taking on more than they can handle. “A lot of people sitting with short-term loans close to zero can’t afford to see them go to 2% or 3%,” he said.

Asset bubbles can emerge when debt is this cheap though.  Especially when there’s no incentive to save.

Depending on who you talk to though negative rates may not be that big of a deal.  It’s the shift of the consumer’s mind to negative rates that can create undesirable outcomes.  So economists the world over are watching these smaller economies closely.

Further reading: What Negative Interest Rates Mean for the World (WSJ)

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categories: banking, economics, government