WHAT ARE NEGATIVE INTEREST RATES?
WE HAVE BEEN TALKING ABOUT NEGATIVE INTEREST RATES FOR A LONG TIME FOR THOSE THAT ARE NEW HERE LET’S HAVE A LOOK. AS A SIDE NOTE FOR ANYONE INTERESTED IN READING FREDERIC MISHKIN YOU CAN DROP HIS NAME INTO GOOGLE AND READ HIS BOOKS. THEY ARE VERY WELL WRITTEN EASY TO UNDERSTAND AND MISHKIN HAS A SOLID REPUTATION. HERE IS HIS BIO https://en.wikipedia.org/wiki/Frederic_Mishkin WHENEVER I SEE HIM GIVING AN INTERVIEW I PAY ATTENTION. OK SO MOVING ON NOW.
Economists never imagined negative interest rates — now they’re rewriting textbooks http://www.businessinsider.com/economists-negative-interest-rates-rewriting-textbooks-2016-10??r=UK&IR=T
If you’re a bank, the idea sounds crazy. Why pay someone to hold your cash?
In 1983, when Frederic Mishkin started writing “The Economics of Money, Banking and Financial Markets,” his seminal textbook on macroeconomics, he never thought he’d devote much space to the idea of negative interest rates.
“A million years no,” Mishkin told Business Insider.
Negative rates were seen as a bizarre thought exercise by academic economists, not something any of us would see in the real world.
It was “absolutely unthinkable when I started writing this book,” Mishkin, a former Federal Reserve governor and professor at Columbia Business School, said.
In fact, it took just about 30 years. And as Mishkin finishes the 12th edition of his textbook, he’s devoting a whole lot of space to negative interest rates.
“There’s something very shocking about this,” Mishkin said. “I have to talk about how negative rates are something that can be very prevalent.”
At a basic level, a negative interest rate occurs when a lender pays someone to borrow its money.
The policy has evolved from radical idea to mainstream policy of post-recession governments in Europe and Asia. And in the US, Federal Reserve Board Chair Janet Yellen has said the US will not rule out using them if it needs to.
This is because the Great Recession has rewritten the rules of what can happen — and how central banks can respond — during financial crises. Negative rates could affect just about everyone, notably businesses, banks, homeowners, and anyone with a savings account.
The old way
Centrals banks, like the Federal Reserve in the US or the Bank of England in the UK, control a country’s supply of money and set the interest rates that apply when a bank lends to another bank, usually to meet mandates for how much each bank has to keep in reserve.
And for much of the past century, our economic system has worked something like this:
You earn money through your job. You deposit some of that money in your bank. The bank takes a portion and lends it out to customers and stores some of the rest at the Federal Reserve. If it has more at the Fed than is required by regulation, it lends the extra to other banks, which might not have enough in reserve. That’s called interbanking lending, and the interest rate we’re talking about when we talk about the Fed changing rates applies to that lending between banks overnight. This is actually the most important rate in the country. All other major interest rates are based on it, at least indirectly.
Changing this rate is a kind of lever that the Federal Reserve can pull to make things happen in the economy. If it wants to spur banks to lend, which should boost the economy, it lowers the rate. That eventually makes mortgages and car loans more affordable for consumers. If it wants to slow a raging economy, it raises interest rates.
And for most of our modern financial history it was inflation — the increase in prices — that kept central bankers up at night. As Kenneth Rogoff, an economics professor at Harvard, recently told Business Insider, when he was studying economics in the late 1970s, “Everyone said we’d never grow fast again. Inflation was double digits.
“If you had told me we’d be in some future where central banks were struggling to get inflation up from zero or 1% and they wanted it to be a little higher, I’d say we’re living in an alternative universe.”
Breaking through the floor
When the Great Recession hit in the late 2000s, central banks did all they could to ease the pain. They lowered interest rates rapidly, a traditional strategy for shoring up free-falling economies. In many places, rates hit zero. When that didn’t do enough, some central banks, such as the Federal Reserve, tried nonstandard ways to boost the economy. The Fed started buying back its own bonds with newly created cash — what’s known as quantitative easing, or QE.
But there was still one thing that seemed unlikely: going negative. In textbooks like Mishkin’s, a 0% interest rate was known as the “zero lower bound.” It just didn’t seem to make sense to go below that.
Now economists have to rename it.
When QE and a zero interest rate weren’t enough in some parts of the world, like Europe and Japan, central bankers did the unthinkable. They started to set interest rates slightly negative.
“You don’t do this on a normal sunny day,” Rogoff said.
What this means, in practice, is that banks that have money to spare would pay to lend it out. The other bank would actually get paid to take on debt.
So far, Sweden, Denmark, Switzerland, and Japan have tried negative rates with varying levels of success. Sweden’s Riksbank was first, in 2009, to take rates below zero. Central banks in Denmark, Switzerland, and the European Central Bank (ECB) eventually followed.
In an important 2012 speech, ECB President Mario Draghi said Europe’s central bank would do “whatever it takes” to save the euro. Inflation was too low, and borrowing costs in Spain and Italy were getting out of hand — so high that Spain was about to ask for a bailout.
Today, countries with negative policy rates make up almost a quarter of global gross domestic product, according to the World Bank.
Low rates for you
Central banks such as the Fed do not set the interest rates that most consumers see in savings accounts, mortgages, and car loans. But the Fed’s rates eventually filter through the economy. If a bank can’t get much for lending money to other banks through the Fed, then it’s not going to pay you much in a savings account.
If rates go negative, then it’s conceivable but very unlikely that banks could pass those costs on to consumers. Savings accounts could have a fee instead of paying interest. That wouldn’t be fun for savers, but it could incentivize people to spend rather than save.
“It’s very hard to obviously get depositors to accept negative interest rates for putting their money in there,” said Marc Bushallow, managing director of fixed income at Manning and Napier, which manages $35 billion in assets.
What’s much more likely is that only big banks will be forced to pay to lend money to one another. That would exempt small depositors from paying, but still have some of the stimulus effects that the central banks intend to have. And everyday consumers would have an easy alternative if they were forced to pay to deposit their cash. They can hoard it under the mattress free of charge.
The cash dilemma
Rogoff has come a long way from those days in the ’70s when he and his colleagues couldn’t imagine central banks even considering negative rates. Now, he says, the experiences of the past few years suggest that central banks will need more room to maneuver in future crises. That could mean rates as low as -4 or -5%.
But that’s nearly impossible when people could just keep their money in cash and avoid the costs of depositing money. So, in Rogoff’s mind, in order for central bankers to have the option to set significantly negative rates, we have to get rid of cash — or at least big bills above, say, $10 or 10 euros. He writes about this in “The Curse of Cash.”
“If they’re going to go to a big negative interest rate, why should I take that when I could hold cash?” he said.
Right now, Rogoff says, in places such as Switzerland, the rates are only slightly negative, and the cost to store and insure cash piles is too expensive for insurance companies and the like to keep their reserves in bills.
And with negative rates so new, Mishkin will have to keep a close watch on whether they work to support flagging economies. He may need to update his textbook once again.
WE ARE SEEING NEGATIVE INTEREST MORE AND MORE AND WE ARE SEEING A SLOW BUT STEADY SWITCH OUT OF THIS BANKING SYSTEM AND INTO A GREEN ONE SPOTLIGHTING EMERGING MARKETS.
TOMORROW WE ARE GOING TO TALK ABOUT VENEZUELA AND I WILL SHOW YOU WHY THEY ARE THE PERFECT MODEL OF HOW TO GO FROM STAND ALONE TO FRONTIER TO SECONDARY EMERGING. AND CURRENTLY THEY ARE OFFERING A 46% RETURN ON BONDS FROM PD VSA IS THE RISK WORTH IT??? WE’LL HAVE TO SEE.
WELL THAT’S ALL FOR NOW UNTIL TOMORROW LIKE US ON FACE BOOK AND FOLLOW US ON TWITTER…GOOD NIGHT ML..
P.S. I’M THINKING TO DO A CALL ON WEDNESDAY THE 26TH WHAT DO THINK? WILL IT BE HELPFUL IN UNDERSTANDING OR NOT SO MUCH…PLEASE LET ME KNOW IN THE COMMENTS BELOW.