Financial experts around the world unanimously agree that unique financial policies need to be implemented in challenging economic times. An example of such is the negative interest rate policy. It means that financial institutions such as banks charge negative interest rates. This means that depositors do not receive money for holding account balances. Instead, they have to pay so as to keep their money in the bank. In this case, the interest rates have a negative value that is below zero percent. Here is more about the reason for this step and the overall Impact of negative interest rate policies.
Why a Financial Institution Can Implement Negative Interest Rates
When the economy is experiencing deflation, people prefer to store cash in their accounts. This leads to lower demand for loans or credit from the banks. Instead of borrowing or lending, people begin to store money enthusiastically. As a result, the prices of commodities can reduce dramatically. If left unchecked, this can cause lower levels of production and service provision. This leads to unemployment and possibly an economic depression. A strict monetary policy such as negative interest rates can be implemented to solve this situation.
Impact of Negative Interest Rate Policies
This type of interest rate obliges depositors to pay money so as to maintain their bank account balances. Due to this financial pressure, they have to find ways of generating more income. This leads to a rise in applying for loans, investing and spending money on income-generating activities. The sub-zero interest rates catalyze the cost of borrowing for individuals and companies. They also drive up consumerism and kick-start the economy.
Simply referred to as NIRPs, these policies initiate artificial inflation in the economy. Cash is forced into the hands of the public so as to spur consumer activity. However, the terms of the rate oblige depositors to keep paying money to the bank so as to maintain deposits. This keeps the inflation rate in check and prevents too much currency devaluation. The combination of having to pay for deposits, lower loan interest rates and more opportunities for investment result in overall economic growth.
- A negative interest rate reduces the cost of maintaining depositors for financial institutions
- It increases the price of goods and services hence preventing a depression
- The policies promote economic activity
- It prompts lower interest rates on loans
- More cash in public hands results in more opportunities for commerce
- Members of the public are required to pay money so as to maintain bank deposits instead of earning interest on these balances.
- If this negative monetary policy is not strictly enforced, it can result in further inflation
- It is a currency devaluation strategy
- Negative interest rate policies are the last option solution
Whenever an economy begins to exhibit signs of impending depression, Negative Interest Rate Policies (NIRPs) can be enforced by financial institutions such as banks and credit unions. Depositors bear extra expenses which reduce cash hoarding and spur economic creativity and activity. Overall, the objective of these policies is to increase consumer spending and revive the economy.