The decision by the Bank of Japan(BOJ) on January 29, 2016 to cut its benchmark interest rate below zero created a new round of headline news on negative interest rates. The BOJ action follows several other European central banks, led by Sweden in 2009, Denmark in 2012 and Switzerland in 2015. The issue is controversial because economists are uncertain about the effectiveness of a negative interest rate policy. One expectation is that negative interest rates will encourage banks to boost lending. However, economists at J.P. Morgan recently predicted that banks may instead hoard cash and cut lending.[1]Leading executives such as Larry Fink, CEO of BlackRock, and Bill Gross, former CEO of PIMCO, are warning of dire consequences and financial ruin.[2]Is the new approach of central banks economically valid or act of desperation, as claimed by some economists.

A brief history of negative interest rates is in order to understand its economic consequences. By definition, negative interest rates imply that a lender pays the borrower for loaning capital. This phenomenon is not new and has been in existence throughout history. In times of wars and recessions, moneylenders and financial institutions often had to spend money to safeguard their capital. During a war, it was safer to keep gold and silver coins inside the king’s castle, even if it meant they may be appropriated by the king.During a recession, it was often safer to pay the only bank in town to store money in their vault than keep it under the mattress. In the end, the economics of money is straightforward; if the opportunity to invest is absent or the risk of investment is high, paying to safeguard money is economically valid.

This justification of negative interest rates was formally articulated by Silvio Gesell in 1906 in his publication, The Natural Economic Order.[3] In an interesting dialogue between Robinson Crusoe and a stranger in a deserted island, Gesell shows that Robinson Crusoe is better off giving his extra hoarding of wheat and clothes to the seafarer in return for something less because the alternative would be to lose the wheat to beetles and the clothes to moths. Keynes, in his 1936 General Theory of Employment, Interest and Money, acknowledges Gesell’s negative interest rates argument but cautions that it only paints half the picture because it ignores the preference for liquidity by investors in a normal market. But we are not in a normal market. The market today is awash with excess cash chasing few investment opportunities in the real sector as countries struggle to regain traction after the global recession. The quantitative-easing policies of central banks has also steered money towards the stock market, raising the average S&P 500 P/E ratio in the United States to nearly 24, even as earnings are down in the first quarter of 2016.

Negative interest rates made its first appearance in the U.S. in December 2009 in the depths of the recession when three-month U.S. Treasury Bills traded above par for the first time.But it has remained more persistent in Europe fueled by the Greek crisis in 2010.Investors dumped Greek, Italian, Spanish and Portuguese bonds for those of Germany, Switzerland, Netherlands, Denmark and Sweden. Unlike the U.S., the recovery in Europe has been sporadic with some countries experiencing a second recession. Basel II’s requirement of additional capital for OECD government bonds with lower ratings further accelerated the decline. By July 2011, rates turned negative and the high demand for some country bonds allowed their central banks to auction off short-term bonds at negative interest rates. In September 2011, Switzerland issued three-month bills at negative rates followed by the Netherlands in December 2011 and Germany in January 2012.

The auctioning of short-term bills and bonds at negative interest rates should not be confused with official negative interest rate policy of central banks. The former is the result of strong demand and preferences by investors for certain bonds.Official negative interest rate policy is different in that the deposits of commercial banks held by central banks are levied an interest rate. Central banks normally allow commercial banks to keep reserves with them at zero percent with the exception of a few countries like the U.S. and England which pay a positive interest rate.

Negative interest rate policy is not entirely new. In 1972, the Swiss National Bank (SNB) charged 2% per quarter on non-resident deposits and raised it to as high as 10% per quarter (40% annual) in 1978 to prevent the Swiss Franc from appreciating. It was period of heightened uncertainty because the U.S. had just announced the closure of the gold window,ending the guaranteed exchange of gold for dollars. The recent round of official negative interest rate policy began with Sweden in 2009 when it began charging 0.25% on its one-week deposit facility. Although the amount of funds placed in the one-week facility was low (most were placed in overnight funds that paid a modest 0.15 percent), it started the ball rolling for other central banks to follow. As of June 2016, the following central banks had officially implemented negative interest rates on bank deposits.

Sweden -0.50% July 2009
Denmark -0.65% July 2012
ECB -0.40% June 2014
Switzerland -0.75% December 2014
Japan -0.10% January 2016

Is negative interest rate policy of central banks bad for the economy as stated by some business leaders?

The discussion below mirrors some of the points raised by Ben Bernanke in a recent article on this topic.[4]

  1. The current lows are already close to zero. Negative rates of -0.10% or -0.20% will only make a marginal difference to banks. Countries like Switzerland and Denmark that have lowered their rates further are not attempting to boost lending but are targeting foreign deposits to defend their currency from appreciating.
  2. Negative interest rates can squeeze bank profits but it is not likely to reduce lending.At the extreme, banks will pass on the cost to their clients. This has already begun in the United States. J.P. Morgan announced in February that it will begin to charge for large deposits,following a number of other banks.[5]Its goal is to reduce deposits by $100 billion this year.
  3. The benefits also are limited. Attempts by Switzerland, Japan and Denmark to prevent their currencies from appreciating has not been successful. There is also no evidence to indicate that banks have increased their lending as a result of negative interest rates.

To repeat, from an economic perspective, it is perfectly okay for central banks to impose a negative interest rate policy. The global economy is currently inundated with idle capital and limited investment opportunities in the real sector (U.S. corporations alone holding $1.7 trillion in cash).The U.S., Europe and Japan are mature economies and the prospects for strong growth is limited unless there is a spurt in global economic activity.Corporations and financial institutions will have to settle for lower rates of return during this period of anemic growth. As soon as the economy grows and demand picks up, we should expect negative interest rates to disappear and become a non-issue.

[1] “Doom Loop Fears Cast Pall Over Bank Shares”, Wall Street Journal, February 11, 2016.

[2] ‘Negative Interest Rates confront Growing Chorus of CEO Critics,” Bloomberg News, April 19, 2016.

[3] Part V. Translated by Philip Pye M.A. and available at

[4] Ben Bernanke, What tools does the Fed have left? Part 1: Negative interest rates,

[5] J.P. Morgan to Start Charging Big Clients Fees on Some Deposits, Wall Street Journal, February 24, 2016.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of the various institutions represented by them.