How low can interest rates go? It cannot go below zero.
Well, Central Banks are changing the script. Interest rates can go well below zero. It’s time to unlearn everything you have known before. The concept of time value of money has just been thrown out of the window. The world has turned upside down. Welcome to the world of negative interest rates.
This is the website of Sweden's Central Bank - Riksbank
European Central Bank was the first major institution to adopt Negative Interest rates policy to boost growth. It did that in June 2014. Now, this year - Bank of Japan has joined the list. There are five Central Banks - ECB, Sweden, Switzerland, Denmark, and Japan - that are following NIRP (Negative Interest rates policy) right now. As per some estimates - more than $7 trillion of government bonds worldwide now yield below zero.
Just THINK about this:
Japan borrowed money this month by issuing bonds for 10 years at an interest rate of less than zero. It means - Japan is being paid to borrow money for 10 years. This is crazy.
The question comes: Why would somebody park money to get negative returns?
The thinking that they can make money on currency. The argument: currency will rise enough to compensate for the negative yield. It's crazy. Swiss Central Bank is pursuing negative rates to counter currency appreciation, read prevent flow of hot money, but now it's a trap when everybody doing the same.
The Logic behind Negative Interest rates policy (NIRP)
The theory is that if you take interest rates negative, people like you and me are going to say, “That’s a silly game! I’m not going to lend my money to governments who want me to pay them. I am going to go into the stock market where I can get positive returns!. The stocks go up and in economics we call it wealth effect. Because we feel we’re wealthier, we go out and spend more. That creates demand and inflation and kick starts the economy” ~ Mohamed El-Erian
It's a policy to fight deflation
How do you fight deflation? - By creating Inflation - By creating demand - By punishing savers and forcing them to spend, which will create demand.
How do you force them - By penalizing anybody who hoards cash. You do that by charging fees on deposits. Central Banks by pursuing NIRP are giving a signal to banks to take additional risk and extend more loans. It's a policy to move the money out of the system.
Is NIRP working?
Nope. The 2008 crisis has made companies and individual very cautious. People are saving in the developed world like never before and hence even though incentives exist to borrow and spend, people are not doing so. The same is with the companies - they are borrowing but to buy back their own shares. Also Central Bank desperation is making people more nervous
The post is only for informational purpose and reflects my understanding of the situation