EU’s Negative Interest Rates – Coming to the US?

June 11, 2014         By: Jane Genova

Will the US Federal Reserve System follow the European Central Bank (ECB) in introducing negative interest rates?

On June 5th, the ECB put in place negative interest rates, or what’s called a “tax on money,” in the 18 nations whose currency is the euro.

Essentially, negative interest rates mean that the ECB imposes a fee on commercial banks to maintain their funds at the ECB. This economic strategy has two key goals.

One, the policy was made to motivate banks to stop “hoarding money.”

Instead financial institutions, the thinking goes, will begin lending more of their money to businesses and individuals.

And, two, it is intended to discourage foreign investors from “parking” their funds in the Eurozone. That is expected to trigger a drop in the value of the euro. From that, EU exporters gain a competitive advantage.

Clearly, negative interest rates put pressure on financial institutions to create, directly and indirectly, a kind of economic stimulus.

The assumption is that tight money has constrained enterprise. It has deterred consumers from boosting their spending. Also, the flood of global investors had upped the euro’s value, hurting exports.

Some frame negative interest rates as a desperate measure, needed for desperate times. During Q1 2014, GDP growth in the Eurozone was 0.2 percent. In May, inflation was 0.5 percent, a 0.2 percent decline from April and well below the ECB’s wish list of a bit below two percent. Deflation is a real fear. Unemployment stands at about 12 percent.

The question is: Will this policy work?

Most recently, in 2012, Denmark introduced a -0.2 interest rate on bank deposits. Among the Danish economic concerns was the rising value of the krone currency. For that, it was effective.

However, lending did not significantly increase, and for businesses, it decreased.  As for consumer lending, borrowing became more expensive. That’s because, as the Danish Banking Association reports,  the banks passed on their losses on deposits to potential borrowers. Consequently there was no uptick in the number of individuals taking out loans.

In 2009, during a financial crisis in Sweden, central banks cut the interest rate to -0.25 percent.  The economic consensus is that the policy had no positive effect.

Those who follow the economic thinking of Janet Yellen speculate that negative interest rates are a possibility in the US.

Back in February 2010, before she became Chairman of the Board of Governors of the Federal Reserve System, she delivered a seminal address to the University of San Diego Business School.

First she predicted that the economy “will be operating well below its potential for several years.” She made that assessment even though she contended that the recession was over.  She also noted that “inflation is undesirably low.”

After the speech, she explicitly said to the media, “If it were positive to take interest rates into negative territory I would be voting for that.”

Whether negative interest rates become a government or macro policy remains unclear. However, on the micro level, a number of financial institutions have already instituted their own version of negative interest rates. The most common form is the fee structure for savings accounts.

Typical of those kinds of charges is the monthly maintenance fee, especially in brick and mortar banks and credit unions. For that reason, Internet or online financial institutions promote that their savings accounts carry no fees.

However, personal finance experts warn consumers to read the fine print on the contracts provided by Internet financial institutions. The absence of fees may only be for an introductory period.  They are also frequently  bundled with requirements.  Those range from keeping a certain monthly balance balance, to the limit on the number of monthly transactions.

Despite the current reality of negative interest rates on some savings accounts, consumers and businesses rely on them for money management.  For example, they are often linked to checking accounts to provide funds for overdrafts. Also, they can enhance one’s financial profile.

Should negative interest rates be introduced officially by the Federal Reserve, all transactions with financial institutions are likely to become more complex. More funds for lending could become available.

But, as in Denmark, that could come at additional cost to borrowers. But a positive could be that savings accounts would be saddled with more fees. That could motivate both businesses and consumers to switch those funds into investments which stimulate the economy.