Negative Interest Rates
Source: Business Standard
GS III: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment
Overview
- News in Brief
- What is Negative Interest Rates?
- Way Forward
Why in the News?
Japan’s central bank raised its benchmark interest rate Tuesday for the first time in 17 years.
- Ending a longstanding policy of negative rates meant to boost the economy.
News in Brief
- The short-term rate was raised to a range of 0 to 0.1 per cent from minus 0.1 per cent.
- It’s the first rate hike since February 2007.
The bank had set an inflation target of 2 per cent as an indicator that Japan had finally escaped deflationary tendencies. - But it had remained cautious about normalizing monetary policy or ending negative borrowing rates, even after data showed inflation at about that rate in recent months.
Why did Japan stop negative interest rates?
Japanese companies have announced relatively robust wage hikes for this year’s round of negotiations with trade unions. Japan had finally escaped deflationary tendencies.
What is Negative Interest Rates?
- Negative interest rates refer to a monetary policy tool used by central banks to stimulate economic activity by charging commercial banks for holding excess reserves.
- In essence, it means that instead of receiving interest on deposits, banks are charged a fee for keeping funds with the central bank.
- This unconventional policy aims to incentivize banks to lend money rather than hoard it, thereby encouraging borrowing, spending, and investment in the broader economy.
Key Facts
- Implementation: Central banks typically implement these rates by setting the interest rate on excess reserves (IOER) below zero, effectively penalizing banks for holding onto excess liquidity.
- Purpose: They are employed during periods of economic weakness or deflationary pressures when conventional monetary policy tools, such as lowering interest rates, are no longer effective.
- Effects on Banks: It can squeeze bank profits by reducing their net interest margins, potentially leading to adverse effects on lending, profitability, and financial stability.
- Impact on Consumers and Businesses: While negative interest rates can incentivize borrowing and spending, they may also discourage saving and investment, leading to concerns about long-term financial sustainability.
Examples of Negative Interest Rates
- European Central Bank (ECB): In response to the Eurozone debt crisis and sluggish economic growth, the ECB introduced negative interest rates in 2014. The policy aimed to encourage banks to lend to businesses and consumers, thereby stimulating economic activity.
- Switzerland: The Swiss National Bank (SNB) implemented this in 2015 to counter deflationary pressures and prevent the Swiss franc from appreciating too sharply. The policy aimed to support exports and economic competitiveness.
- Japan: The Bank of Japan (BOJ) introduced this in 2016 as part of its aggressive monetary stimulus efforts to combat persistent deflation and stimulate economic growth.
Way Forward
- Policy Coordination: Central banks should coordinate their monetary policies with other macroeconomic tools, such as fiscal policy, to ensure a comprehensive and balanced approach to economic stimulus.
- Communication: Central banks should communicate their policy intentions clearly to manage market expectations and minimize uncertainty.
- Evaluation: Regular assessment of the effectiveness and side effects of negative interest rate policies is crucial to adjust strategies and mitigate unintended consequences.
- Exploring Alternatives: Policymakers should explore alternative measures and policy tools to complement or replace negative interest rates, considering their potential limitations and risks.
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