Negative Interest Rate Environment
Candlefocus EditorThe aim of NIR is to incite more investment and spending among producers and consumers by making borrowing and lending more attractive. In this way, the central bank hopes to generate economic growth by allowing the free flow of capital. NIR can also be a way to channel funds from foreign investors into the domestic economy. However, the effectiveness of using NIRs in stimulating the economy is contested, as are the possible long-term effects of this unconventional monetary policy tool.
Sweden and Denmark were the first countries to implement NIRs in 2009/10 and 2012 respectively. These low-cost policies were aimed at tackling 'hot money' inflows and encouraging domestic investment in a time of monetary policy paralysis.
In 2014, the ECB also opted for NIRs in an effort to push up prices and to stop Eurozone economies from falling into a deflationary spiral. Many saw the ECB’s decision as an act of desperation, resulting from the banks inability to meet the required inflation rate. NIRs were meant to prevent banks from parking their money with the central bank, where it was paying less than the inflation rate. Still, NIRs are considered a risky move, as there is no guarantee of success and a risk of a long-term distortion of the money markets.
At the same time, some see NIRs as a potential boon for the economy. If successful, the policy could cause a ‘snowball effect’, stimulating consumption and investment and boosting economic growth. Proponents also suggest that it could free up credit supply, increase the amount of money available for lending, and encourage borrowing.
Overall, the degree to which NIRs are effective and their implications in the long term are currently unknown. Central banks will have to be careful when employing this unconventional policy tool. Still, with mainstream monetary policy tools running dry, it is possible that we will see more central banks turn to NIRs as a last-ditch attempt to boost economic growth.