Why Would An Investor Accept A Negative Interest Rate?
You learned about negative numbers in school. Now, you get to learn about negative interest rates. Currently, the European Central Bank (ECB) pays -0.2 percent on money banks have deposited. By way of comparison, the U.S. Federal Reserve’s Fed funds rate is 0.12 percent.
The idea of negative interest rates – essentially, paying a company or institution to hold and use your money – is confounding. Why wouldn’t you opt for cash instead? Richard Anderson and Yang Liu of the St. Louis Fed explained:
“Negative interest rates fascinate both professional economists and the public. Conventional wisdom is that interest rates earned on investments are never less than zero because investors could alternatively hold currency. Yet currency is not costless to hold: It is subject to theft and physical destruction, is expensive to safeguard in large amounts, is difficult to use for large and remote transactions, and, in large quantities, may be monitored by governments. Currency does not provide even a logical zero floor for market interest rates.”
According to The Economist, banks in the United States and Europe have very significant amounts of cash tucked away with their central banks, thanks to quantitative easing. By paying a negative rate of return, the central banks are encouraging member banks to reduce reserves by lending. The idea is to stimulate economic growth. The catch is borrowers may be in short supply when economic prospects for new businesses are murky.
One unexpected consequence of negative interest rates is some financial firms’ computer systems have had to be reprogrammed because they weren’t set up for negative rates.
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Sources:
http://www.economist.com/news/finance-and-economics/21644203-negative-interest-rates-do-not-seem-spur-inflation-or-growthbut-they-do-hurt (or go to http://peakclassic.peakadvisoralliance.com/app/webroot/custom/editor/02-23-15_TheEconomist-Worse_Than_Nothing-Footnote_5.pdf)
http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm
http://www.brainyquote.com/quotes/quotes/t/thomasjeff120901.html#fzeIu0x06vlQxBFO.99
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