How do negative interest rates work? | CNBC Explains
How do negative interest rates work? | CNBC Explains
One of the tools being discussed as a way to deal with the economic damage of the coronavirus pandemic is negative interest rates. CNBC’s Tom Chitty looks at whether we’ll ever be paid to borrow money.
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Content
0.26 -> When the economy is in crisis,
central banks take center stage.
4.52 -> Central banks are charged
with keeping prices stable
6.96 -> and ensuring economic growth,
among other responsibilities.
10.4 -> To that end, they have
a range of tools at their disposal,
13.18 -> including controlling the supply of money,
setting interest rates
16.28 -> and regulating private lenders.
18.32 -> But one idea being talked about
as a way to shore up a shrinking economy
22.14 -> has the potential to turn the way
we think about money upside down.
26.14 -> Negative interest rates.
33.08 -> In June 2014, the European Central Bank
began a great economic experiment.
37.84 -> Faced with slow economic growth
and inflation way below the bank’s target rate,
42.02 -> the bank did something revolutionary.
It began to charge a negative interest rate.
46.9 -> To understand why this was so radical,
it’s important to think about how interest rates work.
52.06 -> Anyone lending money usually expects
to be paid a fee, known as interest,
56.52 -> to cover the risk or inconvenience
of not having their cash to hand.
60.3 -> We see this with banks paying interest to savers
and consumers paying interest on home loans.
65.4 -> The cost of borrowing, as a percentage of
the original sum loaned, is the interest rate.
69.9 -> But negative interest rates
turn the world upside down,
73.18 -> with borrowers charging lenders
for holding onto their money.
76.5 -> So, what are central banks trying to achieve
by making interest rates negative?
80.689 -> Imagine a big lever that they push back and forth
as they attempt to keep the economy on course.
87.22 -> When central banks transact
with major financial institutions,
90.7 -> changes in the rates received
by these lenders gradually ripple out
94.08 -> through the wider network
of commercial clients and consumers.
97.5 -> When prices are rising and there are fears
that the economy is expanding
101.04 -> at an unsustainable rate,
central banks pull back the lever
104.56 -> and raise interest rates,
making loans more expensive.
107.7 -> But if inflation is falling
and the economy isn’t growing
110.44 -> as fast as it could,
central banks push the lever
113.32 -> and lower the cost of borrowing
to stimulate demand and encourage spending.
117.54 -> But what happens when interest rates are already low
and there isn’t enough lending and spending
122.26 -> to spark the economy back to life?
124.26 -> Central banks can charge financial institutions
for not putting their money to work.
129.26 -> In the same way that you or I
might put any spare cash into a savings account,
133.6 -> commercial banks store their reserves
with central banks.
136.58 -> In a world of negative interest rates,
instead of paying interest on these savings,
140.56 -> the central bank charges financial institutions
for holding onto them.
144.4 -> The idea is to encourage
banks to lend this money
146.56 -> to consumers and businesses,
even if they don’t expect a big return.
150.44 -> As consumers spend and firms invest for the future,
the economy begins to grow again.
155.14 -> So how have negative interest rates
worked out in the real world?
159.02 -> In the wake of the Great Financial Crisis,
central banks across the globe
162.9 -> cut interest rates
to fight the recession.
164.88 -> ...that's towards the aggressive end
of the rate cuts...
166.88 -> ...another three quarter point cut...
168.58 -> ...unprecedented rate cut...
170.58 -> Just a few years later, five central banks found themselves facing further economic difficulties,
175.78 -> and took the plunge into negative territory,
pushing their headline rates below zero.
180.4 -> Although intended as temporary measures,
none of these institutions
183.56 -> have yet been able to lift rates
above zero for very long.
187.2 -> The European Central Bank believes
its negative interest rate policies
190.54 -> have been responsible for up to 0.5%
of economic growth in the euro zone since 2014.
196.44 -> That may not sound all that impressive,
but it still represented more than $65B of GDP in 2019.
203.46 -> Elsewhere results have been mixed,
with the Swedish Riksbank abandoning
206.9 -> its negative interest rate policy despite failing
to consistently reach its inflation target.
212.26 -> What’s the biggest threat to negative interest
rates then?
215.3 -> Cold, hard, cash.
217.34 -> Why watch your savings shrink when you can have
a form of money that holds its value instead?
221.94 -> For large financial institutions
dealing with billions of dollars,
225.64 -> withdrawing everything and stuffing it
under the mattress isn’t an option.
229.16 -> This means they’ll accept the pain of rates
being pushed a little way below zero
232.74 -> as the price of knowing their money’s safe
with their central bank.
235.98 -> But banks are wary of passing on negative rates
to businesses and consumers with smaller balances,
240.89 -> who may find it easier to switch to cash
rather than see their savings shrink.
244.84 -> If the difference between the central bank rate
and the rates they pass on to customers gets squeezed,
249.64 -> that means banks stand to make less profit.
252.28 -> Although that may not sound like a tragedy,
it’s possible that pushing the interest rate lever too far
257.049 -> may put banks under too much pressure
and cause them to lend less.
260.66 -> That’s the opposite of what central banks
are looking for when they lower rates.
264.72 -> Some economists think this ‘reversal interest rate’
is likely to be around -1% in the euro zone.
270.58 -> So far, the lowest central banks’
main policy rates have sunk is -0.75%.
276.1 -> While Danish banks have offered mortgages
with negative interest rates to prospective homeowners,
280.7 -> consumers still aren’t quite being paid to borrow
once fees are taken into account.
285.26 -> And saving for the future is more difficult than ever as
savings accounts and pension funds offer low returns.
291.12 -> A negative interest rate policy may have its limits, and
it certainly won’t head off deflation or recession alone.
297.32 -> But in a world of low interest rates,
don’t be surprised if more central banks
301.78 -> look to turn the world upside down
as economic uncertainty looms.
306.8 -> Hi guys.
Thanks for watching our video.
308.36 -> Whether you're a borrower or a lender, we'd love
to know your thoughts on negative interest rates.
313.3 -> Comment below to let us know,
and remember: subscribe.
Source: https://www.youtube.com/watch?v=6KibetJGVA0