9/25/2019 Negative Interest Rate Definition

MONETARY POLICY INTEREST RATES

Negative Interest Rate Definition

REVIEWED BY BRIAN BEERS | Updated Aug 17, 2019

What Are Negative Interest Rates?

Negative interest rates refer to a scenario in which cash deposits incur a charge for storage at a
bank, rather than receiving interest income. Instead of receiving money on deposits in the form
of interest, depositors must pay regularly to keep their money with the bank. This environment
is intended to incentivize banks to lend money more freely.

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KEY TAKEAWAYS
With negative interest rates, cash deposited at a bank yields a storage charge, rather
than the opportunity to earn interest income.
Negative interest rates might be seen during deflationary periods when people or
institutions are inclined to hoard money, rather than spend or lend it.
The negative interest rate is meant to be an incentive for banks to make loans during a
period in which they would rather hang on to funds.

How Does a Negative Interest Rate Work?

While real interest rates can be effectively negative if inflation exceeds the nominal interest rate,
the nominal interest rate had been theoretically bounded by zero. Negative interest rates are
often the result of a desperate and critical effort to boost economic growth through financial
means.

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Negative interest rates may occur during deflationary periods when people and businesses hold
too much money instead of spending. This can result in a sharp decline in demand, and send
prices even lower. Often, a loose monetary policy is used to deal with this type of situation.
However, with strong signs of deflation still a factor, simply cutting the central bank's interest
rate to zero may not be sufficient enough to stimulate growth in credit and lending.

Important: In a negative interest rate environment, an entire economic zone is

impacted as the nominal interest rate dips below zero and banks and other firms
have to pay to store their funds at the central bank, rather than earn interest income.

Understanding a Negative Interest Rate Environment

A negative interest rate environment is in effect when the nominal interest rate drops below
zero percent for a specific economic zone, meaning banks and other financial firms would have
to pay to keep their excess reserves stored at the central bank rather than receive positive
interest income.

A negative interest rate policy (NIRP) is an unusual monetary policy tool in which nominal target
interest rates are set with a negative value, below the theoretical lower bound of zero percent.

Real World Example of a Negative Interest Rate

In recent years, central banks in Europe, Scandinavia, and Japan have implemented a negative
interest rate policy (NIRP) on excess bank reserves in the financial system. This unorthodox
monetary policy tool is designed to spur economic growth through spending and investment as
depositors would be incentivized to spend cash rather than store it at the bank and incur a
guaranteed loss.

It's still not clear if this policy worked in these countries in the way it was intended, and whether
negative rates successfully spread beyond excess cash reserves in the banking system to other
f h
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parts of the economy.

Related Terms
How the Negative Interest Rate Policy (NIRP) Works
A negative interest rate policy (NIRP) is a tool whereby nominal target interest rates are set with a
negative value. more

Reading Into Negative Interest Rate Environments

A negative interest rate environment exists when a central bank or monetary authority sets the nominal
overnight interest rate to below zero percent. more

What a Low Interest Rate Environment Really Means

A low interest rate environment is defined as a condition when the risk-free rate of interest is lower than
the historic average. more

Zero-Bound Interest Rate

A zero-bound interest rate is the lower limit of zero on short-term interest rates. more

Non-standard Monetary Policy

A non-standard monetary policy is a tool used by a central bank or other monetary authority that falls out
of the scope of traditional measures. more

Tight Monetary Policy Definition

A tight monetary policy is a course of action undertaken by a central bank—such as the Federal Reserve—
to slow down overheated economic growth. more

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