9/25/2019 What Negative Interest Rates Mean for Investors

INTERNATIONAL INVESTING GETTING STARTED

What Negative Interest Rates Mean for Investors

BY JUSTIN KUEPPER Updated June 25, 2019

Most people are familiar with the risks of inflation, where the value of a currency plummets
and everything becomes more expensive. In places like Venezuela, these issues have
become so severe that there’s a black market for dollars as a secondary currency for
exchange. Post-war Germany and Argentina are two other examples of inflationary
pressure that sent consumer prices soaring and hurt consumer pocketbooks in a big way.

Deflation is a much harder concept for people to understand – that is, when the
appreciation of a currency becomes a problem. In layman’s terms, deflation causes people
and businesses to hoard cash rather than spending and investing it, which reduces
demand for products and services and puts downward pressure on prices. Lower prices
can lead to reduced profits and less economic growth, which in turn leads consumers to
hoard even more cash.

In this article, we’ll take a look at one unusual way to beat deflation that’s being
increasingly employed by central banks around the world since the 2008 economic crisis.

Negative Interest Rates

Interest rates are the single most important monetary policy tool used by central banks to
influence inflation throughout an economy.

A central bank attempts to combat deflation by reducing interest rates in order to

encourage consumers and businesses to spend money and raise prices. In some cases,
these conventional monetary policies don’t work and the central bank will lower interest
rates into negative territory. The move is designed to incentivize banks to lend money and
businesses to spend money rather than pay a fee in order to keep it safe at a bank.

There are many di erent instances of negative interest rates throughout history, but more
recently, these policies have been used to ward o deflation. The European Central Bank
introduced its negative interest rate policy in 2014, and in January of 2016, the Bank of
Japan unexpectedly did the same, cutting its benchmark rates below zero in a bold move
to stimulate its economy and overcome persistent deflationary pressures in its economy.
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The graph below illustrates Japan's 10-year government bond yields from 2012 through the
present.

Japan 10-Year Government Bond Yields: 2012—Present

In Japan, the government set interest rates below 0% in an e ort to combat de ation and stimulate consumer
spending.

1%

0.8%

0.6%

0.4%

0.2%

0%
-0

-0.2%
2012 2013 2014 2015 2016 2017 2018 2019

Impact on Economy & Markets

The impact of negative interest rates is di cult to quantify since the policy has been used
sparingly in the past, but there’s some evidence it might be working.

Banks may be reluctant to pass on the cost of negative interest rates to their customers
because doing so may encourage them to move their assets. In these cases, lower interest
rates would lower the profits of banks and discourage them from lending to riskier
parties. Consumers facing a cost of having cash in the bank may decide to take the money
out of the financial system altogether – although that scenario hasn’t materialized yet.

The impact of these policies on the foreign exchange market has been much more
favorable. When negative interest rates are in place, investors tend to search for better
returns in foreign markets, which sends a currency’s valuation lower. Lower currency
valuations help boost exports by making them more attractively priced around the world.
The Euro has seen these dynamics with regards to its exchange-rate with the dollar since
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y g g
2014.

Key Takeaway Points

• Negative interest rates are designed to combat deflation by encouraging people and
businesses to borrow and spend money.

• Negative interest rate policies have been implemented a few times in the past, but their
e ects are di cult to quantify.

• Some economists believe that banks will be reluctant to charge customers, which could
hurt the financial system even more.

• Other economists believe that negative interest rates could send capital abroad and
ultimately help lower a country’s currency valuation to bolster exports.

GLOBAL MARKET BASICS

Japan's Lost Decade: A Brief History

and Lessons Learned

GETTING STARTED

What Is an Exchange Rate Mechanism

(ERM)?

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GETTING STARTED HOT TOPICS

How Fiscal and Monetary Policy What Is The Current Fed Interest Rate
Influences an Economy and Why Does It Change?

UNDERSTANDING STOCKS

How Rising Global Interest Rates

Impact International Stock Markets MACRO TOPICS

Higher Interest Rates and Commodity

Prices

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RECESSIONS

GETTING STARTED What Happened During the Great

Take a Look at These Solid Strategies Depression?
to Mitigate Interest Rate Risks

NEWS

Fiscal Policy vs. Monetary Policy

MACRO TOPICS

Rising Interest Rates Tend To Be

Bearish For Commodities

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ASIA
ASIA
Does China Manipulate Its Currency?
7 Reason's Japan's Economy Is Stuck

FOREIGN CURRENCIES
MONETARY POLICY
What Are the Causes of — and
Why Do Interest Rates Ever Need to Solutions to — a Currency Crisis?
Rise?

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MONETARY POLICY
TRADE POLICY
Why the Fed Must Raise Interest Rates
Why Global Currency Wars Aren't as
Dangerous as They Sound

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