Negative interest rates used to be a controversial topic. However, countries such as Japan and those in the European Union entered into the uncharted waters to stimulate their economies in the years following the Great Recession. Back in 2015 there was speculation that the US was headed into negative interest rates too. But those thoughts quickly vanished as the economy rapidly expanded after 2016. But with the prospect of more economic distress down the road with on-and-off again lockdowns and business restrictions, are negative interest rates on the table again?
What are “negative interest rates?” A very rudimentary explanation is it’s when interest rates go below zero. Meaning that instead of borrowers paying interest on loans, the lender pays the borrower. It may sound backward to what we are used to, but it is a “tool” that central bankers may employ in times of severe financial crisis.
Although many economists contend that negative interest rates are a viable short-term option to respond to a severe financial crisis, it is uncertain the policy works as intended. Negative interest rates expose a vulnerable economy to future financial downturns. Additionally, some are concerned about long-term deflationary effects, while others fear it results in hyperinflation. Some experts point to the potential of a paradoxical effect of freeze community lending. This can occur if investors hold onto their cash, instead of depositing it with banks for zero interest (or even having to pay the bank to hold their money). This lack of investment has the potential will reduce banks’ available capital to lend.
The possibility of negative interest rates in the US is once again a hot topic. A 2020 NAR report discusses this option (Expectations & Market Realities in Real Estate 2020-Forging Ahead; nar.realtor):
“There is nothing stopping the U.S. from moving into negative interest rates, but several issues would arise should the U.S. decide to take that plunge. One of the biggest fears is that the FOMC [Fed Open Market Committee] would not have any tools left to employ when the next downturn occurs. Global investors might lose faith in the safety of U.S. government bonds as negative interest rates and other forms of quantitative easing may be perceived as a sign of weaknesses in the economy. In addition, the portfolios of millions of U.S. investors would likely be hurt. According to the Office of Management and Budget, $16.8 trillion of the government’s $22.7 trillion debt is held by the public of the U.S. A large portion of the holders of U.S. debt are retired or soon-to-be retirees who have their portfolios in risk-free U.S. Treasurys. Many federal programs, including Social Security, Medicare and Medicaid, are also heavily invested in Treasurys, meaning these public programs would most likely lose money on the aggregate due to negative interest rates.”(Expectations & Market Realities in Real Estate 2020-Forging Ahead; nar.realtor)
Could we see negative interest rates in the US?
In their recent statement of the FOMC (federalreserve.gov), the Federal Reserve believes that although economic activity and employment are recovering, the health emergency has caused a tremendous human and economic hardship in the US (and globally as well). If extraneous events are unchanged, “Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.” However…“The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
Original published at https://dankrell.com/blog/2021/01/04/negative-interest-rates-redux
By Dan Krell
Copyright © 2021
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