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InvestmentBank.com | A Negative Interest Rate Policy (#NIRP) Is “Mind Blowing” in its Repercussions
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22 Feb A Negative Interest Rate Policy (#NIRP) Is “Mind Blowing” in its Repercussions

Am I the only one whose mind is being literally blown by the wildly crazy economic experiment being played out by the ECB, Japan, Denmark, Sweden & Switzerland? The potential impact is still in limbo as the world waits to see how negative interest rates will impact economic conditions. Some of the potential repercussions on financial decision-making are astounding. And while the Fed at one point said they would likely not pursue and NIRP, Janet Yellen has also stated that, “it’s not off the table.” Unfortunately, the Fed has exhausted all the tools in its proverbial tool kit, making it more difficult to avoid a NIRP if the economy gets soft again.

The Intent of NIRP

The desire of a NIRP is similar to that of the infamous Quantitative Easing (QE) strategy. The ultimate goal is to ease credit restrictions, support financial stability and get money flowing more freely into an economy. To be clear, the Fed likely is less concerned with consumer credit as they are with large corporations (including banks) hoarding cash and not lending for things like acquisitions, research & development or corporate expansion. In short, NIRP it is an effort to more heavily stoke the fires of inflation for both consumers and businesses. In a negative interest rate world, holders of cash are effectively punished for holding their cash, thus inducing a greater flow of liquidity between banks, business and individuals. That is the ultimate intent of following a NIRP.

Downsides and Collateral Damage

Unlike a simple reduction in the inter-bank rate or lowering of the Federal Funds Rate through QE, NIRP has other positive and negative impacts as well. During a NIRP scenario, lenders are penalized for parking cash in the central bank in hopes that lenders will lend and not hold cash.

In addition, negative interest rates reduce the profit from interest while at the same time increasing the cost of borrowing on the side of the lender. Sub-zero rates also discourage banks from expanding operations. We are already seeing this negative impact on bank assets/valuations across Europe. Since January 30, 2016 when Japan announced its NIRP, Japanese bank stock has fallen by 30%. Similarly, European bank stock has declined by 28% over the same time period.negative interest rates

The experiment does not seem to be working out as intended, thus far. For instance, inflation expectations for Japan have not only declined since last month, the interest rate cuts there have caused the yen to appreciate by 9%. Remember exporters prefer a weak national currency. NIRP does not seem to be positively impacting Japanese production. There is an argument that the effort toward negative interest rates will ultimately fail.

Chris Xiao of BofA Merrill Lynch put it well when he warned that “US deflation or major declines in global financial assets as implicit global central bank puts disappear”.

Crazy Incentives

Some of the personal saving and spending incentives encouraged by a negative interest rate policy are crazily mind-blowing. While the only rate the Fed can truly control is the inter-bank lending rate, lowering this rate to sub-zero will have trickle-down effects on consumers and businesses alike. For instance, think for a moment if you were charged for holding cash in a bank account or if instead of receiving a net 30 discount on your payables if your business paid early, you were charged for doing so. It gets crazier still. Think of a bond investor who invests $1,000 today, but upon receipt of her bond months or years later, she only receives $995. This impacts savings, retirement, spending, lending, borrowing and investment– across the board.

When discussing negative interest rates, the inverse incentives of working with them are extremely backwards. We are running a very risky economic experiment right now–one which the Keynesian and Monetarists will be discussing for decades to come.