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While it's hard to imagine what a negative-interest-rate economy would look like in America, it's not unfathomable. Japan and various countries across Europe have had negative interest rates for years, and after the recent Federal rate cut, which brought the Federal base rate down to between 0% and .25%, the idea that the United States could have negative interest rates in the very near future is becoming more of a reality than ever before.
As Congress and local municipalities take aggressive measures to try and prevent the spread of the coronavirus, the slowdown the economy is feeling today is just the beginning. The true impact it will have on the economy is still unknown and will be for quite some time.
Why would interest rates go negative?
The goal of low, and even negative, interest rates is to promote borrowing and purchasing by consumers. When rates are low, the cost of borrowing is low, which in a perfect world means people will spend money. But negative interest rates are not a preferred way to stimulate the economy and are therefore usually employed as a last resort to try and grow the economy through difficult economic times.
What would a negative-interest-rate environment look like?
In a positive-interest-rate environment, those borrowing money pay interest to the lender in addition to the principal amount borrowed. The higher the interest rate, the more you pay to borrow money. This applies to all borrowers, including consumers getting a business or home loan or lending institutions borrowing and lending money in the short term.
Additionally, in a positive-interest-rate environment, banks pay a nominal interest rate for money held in accounts, which currently ranges from 1% to 2.5% for a high-yield savings account.
In a negative-interest-rate environment, it would be the exact opposite. Consumers would pay the bank to hold their money each month, and hypothetically, if mortgage rates ever reached 0% or below, lenders would pay the consumers to borrow money (but that situation is extremely unlikely). This also means lending institutions would have to pay each other to borrow money in the short term. Negative interest rates would directly affect bond and Treasury yields and disrupt the financial market.
Since saving money would cost consumers, most would be prompted to withdraw their money from the bank, saving or spending the money, searching for a return that can beat the rate of inflation. This can lead to a bank run, where there is a rush of people attempting to withdraw their money from the financial institutions all at once, which is especially concerning considering the Federal Reserve just lowered the banks' lending reserve ratio to zero, which means the banks are no longer required to have a single penny in reserves to match customer deposits.
For interest rates to go negative, the central bank (in our case the Federal Reserve) would need to lower the Fed base rate by 25 basis points or more, which honestly is not that far of a leap from where we are today.
Right now, no one -- the Fed included -- knows whether we'll adopt negative interest rates. But for the time being, they are taking every measure possible to keep the United States out of negative-interest-rate territory for as long as possible. Investors and consumers concerned about a negative-interest-rate environment should create a contingency plan for what they intend to do with their money and investments in that environment and keep a close eye on the current market and economic policies being put into place.
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