Paying to Save
Imagine the situation where depositors need to pay to keep their money in the bank; or in another word receiving at maturity an amount less than what they had originally deposited. This is essentially what below zero or negative interest brings about.
Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there since 2014. Now Japan is trying it, too. The Bank of Japan surprised markets Jan. 29 by adopting a negative interest-rate strategy. The move came 1 1/2 years after the European Central Bank became the first major central bank to venture below zero.
Some economists consider this dangerous. Some reckon it shouldn’t be possible at all. In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress instead.
So, what is on the cards for Japan? Japan has been plagued by deflation – falling prices – for two decades, deterring consumer spending and business investment in the expectation that goods will become cheaper. Instead of earning interest on money left with the BoJ, banks are charged to park their cash. The idea is that instead of depositing money with the central bank or each other, they lend it to businesses and consumers. Banks may also cut deposit rates paid to customers, encouraging them to spend or invest instead of earning low or negative returns. The whole idea of the move was to help beating deflation. Negative rates might send investors in search of better returns abroad, leading to depreciation of the currency. That would raise the price of imports, helping to combat deflation and giving a growth-enhancing boost to exporters.
Japan’s move to keep interest rate negative proves that the previous quantitative easing move yielded very little results, causing it to try something it had never done before. Whether it is going to be successful is yet to be seen by there are underlying risks with the move. So what are the risks of negative rates? The obvious one is that at some point Japanese savers, most of which are corporations at this point might start moving their money out of the country. Capital flight would necessitate a rapid reversal of interest rates, and might even spur hyperinflation, a run on the Japanese currency itself.
Good luck Japan!