Denice R. Preston
The Western world has experienced unprecedentedly low interest rates in the last year. The interest rate is a vital instrument of the monetary policy that a nation’s central bank governs to encourage investment, employment, and inflation levels. Low interest rates stimulate more significant investment and spending due to the opportunity cost of low yields offered by cash savings accounts.
Before that time, rate cutss and rises were usually mostly cyclical and coincided with the booms and recessions that the economies experienced. The relationship between rates and crashes has recently weakened, and we’ve seen interest rates struggle to encourage growth. In the meantime, certain economies have taken a radical step to move them towards hostile areas.
What are negative interest rates, and how do they function? Lenders essentially compensate borrowers for the privilege of taking their money. It sounds a bit shady; however, it’s an indication of the current economic situation with high cash in circulation and insufficient demand for investment.
What Nations Have Experienced Negative Base Rates?
Four countries and one currency block currently face an environment of negative interest rates that began within the last Decade. In the US, The Federal Reserve cut rates for the first time in 11 years in July of 2019, and some are anticipating a warning indication of negative rates to come on the American side.
Given the current economic situation, instances of countries having zero interest rates are being studied to find out the effectiveness of these policies. Examining what has been successful and what hasn’t provides a clear picture of the motives behind and consequences of damaging rate policies.
The Importance of the Base Rate
Central banks establish base rates that can be referred to by various names, including the target rate, policy rate, official bank rate, and repo rates. Essentially, they all define the amount (and the offer) that central banks will offer licensed banks to transfer (or take out) cash for the night. Because overnight deposits go to the most reputable institution in the country (if the central bank goes insolvent, its economy would have collapsed entirely), the interest rate is effectively a nation’s safe rate. The base of this rate will determine yield curves for the domestic market, which range from the federal government to consumer and corporate credit products.
Let’s now look at the adverse effects of negative interest rates and why central banks have turned toward them in the first place.
Stimulating Inflation
After the collapse of the asset bubble, which began at the end of 1991, Japan was faced with a lost decade of economic stagnation that lasted for more than 20 years, according to some. The Japanese economy is in a first in the wake of its collapse, and its Nikkei 225 Index is currently in the vicinity of 50 percent of the 1989 record highest. Inflation (or the absence of it) has been a significant problem in Japan’s economy. The Bank of Japan has experimented with various policies like low interest rates, the printing of money, and quantitative easing to spur growth.
Japan provides a compelling economic case study because it is a well-developed, self-contained island economy. Contrary to the countries of Europe where financial ill-effects are apex across borders.
It was in 1999 that interest rates were first the zero mark at zero in Japan. Since then, the most significant inflation observed was 2.36 percent in 2014, attributed to a one-time pre-emption due to increased sales taxes. In 2016, rates sank negative, dropping to -0.1 percent, and have remained in that range until.
Sweden: Importing Inflation
Sweden is an export-oriented economy, and its central bank, the Riksbank, closely follows the inflation targeting. In contrast to its neighbor Denmark (discussed further below), There aren’t specific goals for targeting currency pegs. To boost the economy and consequently decrease the value of its currency, which is the krona, Sweden turned to negative rates in 2015.
In the last year, Sweden’s krona declined by 15 percent compared to the Euro. However, exports have not grown dramatically, and companies have accumulated profits abroad. A negative rate has not stopped Swedes from investing; Swedes have the world’s third highest savers per capita. Like Denmark, home prices have increased greatly in real terms since the mid-1990s.
The Swedish experiment has had mixed results. Negative rates have impacted the inflation rate, and the country’s economy is among Europe’s most vital. In contrast to Denmark, the main reason for Sweden’s success is using negative rates to achieve a larger objective of increasing exports. Denmark’s Euro peg goal means that its monetary and economic policy can be considered a proxy toward the intentions of the ECB.
Defending Currencies
The foreign policy and economies of Denmark and Switzerland differ in a significant way. However, both have a tradition of monitoring their currencies’ exchange rate against the Euro. Being major trading partners to the EU and its larger regional counterparts, they are in a position to keep a steady flow of their currency so as not to interfere with export or import transactions.
Following the Great Recession and various contagious financial crises in nations like Greece and other countries, the two countries Switzerland and Denmark were more well-known for their status as countries that were considered haven economies. Unaffected by Eurozone fiscal regulation (and about Switzerland, EU membership) to investors, they were perceived as credit-worthy sovereign countries and in complete control of fiscal and monetary instruments, nevertheless, with favorable trading access to the EU (the world’s second-largest economy).
The problem with safe-haven economies is that capital flows seek safety by investing in risk-free and liquid assets. This isn’t a great idea for a country’s economy in the long haul, since these kinds of help can’t be lent by banks or used to develop transformative projects. In both cases, Switzerland and Denmark were forced to implement Negative interest rates in a sure way to prevent their exchange rates from rising compared to the Euro.
