Negative Interest Rates

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A negative interest rate means banks would pay a small amount of money each month to keep some of their money at the Federal Reserve – a reversal of how a bank typically works. [1]

Usually, a lender charges a borrower a percentage rate for a loan. For example, someone may ask to borrow $1,000 and the lender will charge them a (say) 5% annual percentage rate, so if the $1,000 is paid off in a year the borrower pays an additional $50 to the lender that gave them the loan. Lenders take a risk the borrower might default, so an interest rate is charged to encourage the lender to lend money to people. In general, the higher the risk to the lender the higher the interest they charge.

Negative interest rates reverse this. In this case the lender pays the borrower to borrow money from them. On the face of it this makes no sense, but it can be a tool for central banks that want to stimulate their country's economy but have no other means to do so. Offering a negative rate encourages banks to borrow money from the government which the banks will, presumably, use to lend to businesses and individuals as a means to encourage spending and encourage economic growth.

This is usually seen as an extreme measure for a central bank to take and its usefulness is highly debated.[2][3]


References

  1. Trump wants Fed to cut interest rates to zero or below. Here's what it could mean for you.. USA Today.
  2. Negative Interest Rate Definition. Investopedia.
  3. Negative Interest Rate Skepticism Grows at the European Central Bank. Bloomberg.