Originally, the idea behind the negative interest rates was to flee from the deflation stage in an economy, which Europe feared in 2014. It is an unorthodox path, which had not been taken by any other zone as big as the euro zone, until the Japanese economy decided to pursue policies on the same lines as the ECB. The combination of policies of targeted long term refinancing operations, lowered interest rates and quantitative easing stems from an urgency for an economic push that Europe needs to get the economic activity at a faster pace and attain an inflation goal. Theoretically negative interest rate imply that the depositors (this is not happening in practice yet since the banks do not want to pressurize depositors to pay a fee to keep deposits; they take the costs on themselves, which inevitably reduces their profit margin) pay the commercial banks a fee to keep their money; this could encourage banks to give out loans as keeping reserves in excess of the required reserve could prove costly and increase borrowing from the banks, therefore giving a spark to the economy.
Specifically Europe which still hasn’t completely recovered from the 2008 financial crisis and experiences falling oil price (causes further deflation), decides to keep the Main Refinancing Operations(MRO) rate at 0% and negative rate of interest of marginal deposit at the central bank to persuade the commercial banks to borrow more easily from the ECB and avoid excess accumulation of reserves. The funds received by the banks are loaned to the investors, who further invest in any investments that give a return higher than 0%. This mechanism idiosyncratic to the European Economy may work in its favour as the ECB attempts to use limited economic tools to stimulate the economy and keep it from the economic slump.
Well, the concept cannot be as simple as it seems in theory, which relies on assumptions. Negative interest rates can backfire in the following way-If consumers feel the impact of negative interest rate, it can force them to withdraw their money from the banks and put them under the carpets. Consequently, if the banks have lower deposits, they would be unable to lend, reducing the money supply in the economy, and crumbling it even further. A solution to this proposed by ECB would be the traditional monetary transmission mechanism, which, in mundane words, is a transfer of money from the central banks to commercial banks; this technique will work in the absence of deposits and low interest by other interest producing investments.
The above explained consequence can create an effect opposite to the one intended. Besides the “Beggar thy neighbour” stamp that Europe (due to the overly depreciating currency) may confront by the economies in the rest of the world, a modest wage growth and a negative interest rate could lead to paranoia in the markets and rebuild the problem of hoarding of money, which was ironically the initial reason for the peculiar monetary policy. Although, on the positive side, the depreciation of the currency makes it cheaper for the economy to export more than import; another tool used to stimulate the respective economies by central banks all over the world in the so called currency war.
One of the few practical solution to this problem is the tiered rate system; this mechanism originates from the idea of exclusion of some bank depositors, especially the small depositors, from the fee that one needs to pay a commercial bank as a result of negative interest rates. But the recent announcement about cutting the interest rate further could affect commercial banks and people in ways other than expected. As every economy is peculiar, and their respective central bank are fully conscious of the steps they take towards a better economy, the fruits of the policies may not be witnessed in the market over the half hour of the speech given by the president, but will be felt in the long term.
Anukriti Maaharay
Specifically Europe which still hasn’t completely recovered from the 2008 financial crisis and experiences falling oil price (causes further deflation), decides to keep the Main Refinancing Operations(MRO) rate at 0% and negative rate of interest of marginal deposit at the central bank to persuade the commercial banks to borrow more easily from the ECB and avoid excess accumulation of reserves. The funds received by the banks are loaned to the investors, who further invest in any investments that give a return higher than 0%. This mechanism idiosyncratic to the European Economy may work in its favour as the ECB attempts to use limited economic tools to stimulate the economy and keep it from the economic slump.
Well, the concept cannot be as simple as it seems in theory, which relies on assumptions. Negative interest rates can backfire in the following way-If consumers feel the impact of negative interest rate, it can force them to withdraw their money from the banks and put them under the carpets. Consequently, if the banks have lower deposits, they would be unable to lend, reducing the money supply in the economy, and crumbling it even further. A solution to this proposed by ECB would be the traditional monetary transmission mechanism, which, in mundane words, is a transfer of money from the central banks to commercial banks; this technique will work in the absence of deposits and low interest by other interest producing investments.
The above explained consequence can create an effect opposite to the one intended. Besides the “Beggar thy neighbour” stamp that Europe (due to the overly depreciating currency) may confront by the economies in the rest of the world, a modest wage growth and a negative interest rate could lead to paranoia in the markets and rebuild the problem of hoarding of money, which was ironically the initial reason for the peculiar monetary policy. Although, on the positive side, the depreciation of the currency makes it cheaper for the economy to export more than import; another tool used to stimulate the respective economies by central banks all over the world in the so called currency war.
One of the few practical solution to this problem is the tiered rate system; this mechanism originates from the idea of exclusion of some bank depositors, especially the small depositors, from the fee that one needs to pay a commercial bank as a result of negative interest rates. But the recent announcement about cutting the interest rate further could affect commercial banks and people in ways other than expected. As every economy is peculiar, and their respective central bank are fully conscious of the steps they take towards a better economy, the fruits of the policies may not be witnessed in the market over the half hour of the speech given by the president, but will be felt in the long term.
Anukriti Maaharay