Explained: What are negative interest rates and how do they work?

News:US President has criticized the US Federal Reserve for having increased the interest rates in the US economy thus undermining the competitiveness of the US firms and has called for introducing Negative interest rates.


What are negative interest rates?

  • Negative interest means instead of the bank paying you money to keep in a savings account,you pay the bank to do so. 
  • It also means that anyone can borrow money from the bank and pay back less than what he borrowed.

Benefits of Negative interest rates:

  • Negative interest rates are expected to make consumers save less and spend more.
  • They are also expected to make banks lend more.In essence,negative interest rates are expected to boost economic activity when all other efforts fail.
  • It also weakens a country’s currency rate which gives a country’s export a competitive advantage and boosts inflation by pushing up import costs.

Disadvantages of Negative interest rates:

  • Negative interest rates completely alter the way normal investment and savings behaviour function because now a saver is paying for parting with cash and a borrower is being perversely incentivised to borrow more.
  • The financial viability of banks may also come under strain if the loans they extend lose money by design.
  • There are also limits to how deep central banks can push rates into negative territory by depositors can avoid being charged negative rates on their bank deposits by choosing to hold physical cash instead.

Have negative interest rates work?

  • Sweden did it first in 2009 but now European Central Bank rates are also negative as are Japanese rates. 
  • The data shows that European economies and Japan which has a negative interest rates continue to struggle with growth. 
  • For the most part,people have not spent the cash and because of that, businesses haven’t taken new loans to set up more production capacities.