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Old 03-03-2016, 06:17 PM
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Mary Pat Campbell
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Join Date: Nov 2003
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http://knowledge.wharton.upenn.edu/a...ign=2016-03-02

Quote:
“Negative rates are a sign of desperation, a signal that traditional policy options have proved ineffective and new limits need to be explored,” the Bloomberg analysis said. “They punish banks that hoard cash instead of extending loans to businesses or to weaker lenders. Rates below zero have never been used before in an economy as large as the euro area.”

In other words, there’s not much history to indicate what will happen.

Negative rates are intended to produce an incentive to spend rather than save, and spending should help fire the economy and push prices up. Europe and Japan have resorted to negative rates to reduce the risk of deflation, which has many damaging effects such as making debt payments more burdensome over time.

Central banks have direct control only over short-term rates, such as those charged to financial institutions that keep overnight deposits on central bank books. But trimming short-term rates tends to ripple through the economy, causing a drop in long-term rates that are governed by supply and demand. In part, that’s because long-term rates on things like bonds or mortgages are based on views of what short-term rates will be in the future.

“Once you start affecting the cost of capital for banks, then this will affect the market price of assets they buy and the loans they make,” Goldstein says.

Lower interest rates also tend to reduce a currency’s value, since savers’ demand will drop as they shift to better-paying investments in other currencies. A devalued currency can boost exports and it can raise inflation by making imports more expensive. Japan’s turn to negative rates was largely an effort to devalue the yen — although it seems to be backfiring.

In practical terms, a slightly negative rate is not much different from the slightly positive rates that short-term savings have earned for years. After all, earning 0.1% is not much better than losing 0.1%. And after accounting for inflation — reflected in the so-called real interest rate — savers actually have been losing money for years.

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