Negative interest rates occur when the nominal rate paid on deposits, government debt or other financial instruments is less than zero. Economists who equate savings with capital investment criticize the policy, arguing it undermines sound money principles. Negative rates have emerged around the world, and Arkansans would benefit from being aware of the development.
How could negative rates occur when currency exists as an alternative? Currency is not costless to hold, a 2013 Federal Reserve Bank of St. Louis article noted. It is subject to theft, expensive to safeguard, and difficult to use for large and remote transactions. Two domestic negative rate examples are cited: large, Federal Deposit Insurance Corp.-insured non-interest-bearing demand deposits, and yields on certain U.S. Treasury inflation-protected securities.
These are other examples. The European Central Bank cut its bank deposit rate last year from zero to negative 0.1 percent, "to encourage banks to lend to businesses rather than hold on to money." The bank then cut its deposit rate again, to negative 0.2 percent, and it's possible it could send rates lower in December.
Rates are more negative in several instances. Denmark's rate of interest on certificates has been negative 0.75 percent since early 2015. "This is an all-time low and Denmark, along with Switzerland, has the world's lowest key monetary policy rates," a 2015 Danmarks Nationalbank article notes. Large "deposits from firms and institutional investors are extensively paying negative interest rates."
The Swedish Riksbank has also set its benchmark rate at negative 0.35 percent.
The Federal Open Market Committee, by contrast, has signaled its intention to raise domestic rates, though one committee member expressed that a negative fed-funds rate might be appropriate, the September committee rates "dot plot" shows.
What are the implications of negative rates? The first is that "borrowers receive, and creditors pay, interest," a 2012 Federal Reserve Bank of New York article explains. Savers are punished; consumers might change their behavior. A credit-card holder "might choose to make a large advance payment and then run down the balance "with subsequent expenditures, reversing the usual practice of making purchases first and payments later."
The federal debt's interest component might be reduced if the U.S. Treasury could issue long-term debt instruments with negative yields. Japan, Finland and Germany are among nations selling debt at negative rates this year.
State governments would face a different issue: assumptions about fixed-income returns used to calculate pension obligations would have to be adjusted downward.
Negative rates have emerged with weak economic recovery or technical recession in the developed world. Critics argue the two are synonymous.
"Zero or negative interest rates can only subsist if we expect sustained declines in the economy. Otherwise, they can only come about due to the manipulation of money and credit by the authorities," says Dr. Alejandro Chafuen, president of the Atlas Network, a Washington think tank.
"Money is sound when it embodies the same virtues we all try to nurture in our children: honesty, trustworthiness, reliability," explains Atlas' Dr. Judy Shelton.
Thinking about negative interest rates is the monetary equivalent of traveling outside our solar system. But the policy does not equate with sound money because savings and investment are hindered.
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Greg Kaza is executive director of the Arkansas Policy Foundation, a Little Rock think tank founded in 1995.
Editorial on 11/21/2015