I understand that this is designed to stop deflation, but what does it mean practically speaking?
In: Economics
Alright, imagine you have some money saved up in a piggy bank. Normally, if you keep your money in the bank, they give you a little extra money in return, called “interest.” But in Japan, the situation was a bit different. Instead of giving you extra money, the bank might actually take a tiny bit of your money away each year. This is what’s called “negative interest rates.”
Practically speaking, it means that if you keep your money in the bank, you might end up with a little less over time instead of a little more. The idea behind negative interest rates is to encourage people to spend their money instead of saving it, which can help boost the economy when things are slow.
You have to give banks money to store your money. Normally when a bank stores your money, it invests it and then gives you back some of that money. This is the opposite.
So you can see why this encourages spending.
In a normal system, the bank borrows your money to buy a lot of government bonds and a bit of shares/investments or lend it to people at the rate of goverment bonds + some extra called *spread* and pays you back a small fraction of the money deposited they borrowed.
In a deflationary system, the government either doesn’t issue government bonds or simply issue bonds at a very low “interest” rate such as that the bank cannot cover their operational costs without charging their clients in some way.
Japanese banks do it with both extremely high banking fees for services as well as having negative interest rates – they charge people for storing their money instead of paying people for storing their money.
If you are a bank or large lender and someone wants to borrow money from you, say to buy a house or a car, you as the bank can go to the central bank (bank of England, federal reserve etc.) and ask for a loan. The central bank charges big borrowers the prime rate. Say 1%. The bank then charges the customer money, say 2%. The bank makes a profit on the spread between the rate they pay and the rate you get. Some percent of loans default and they have a cost to administer the loans so it’s not pure profit.
The money supply is then determined by how many people want to borrow new money at this prime rate, versus borrowing it from someone else at a potentially lower rate. If you could make 1% lending your money to the government or 1.5% to people buying cars, you might lend to people buying cars and they would take that deal vs 2% from someone else.
A negative interest rate means the central bank is paying large commercial borrowers (banks, mortgage companies, large car companies) to borrow money. Say – 0.5% means they are paying you half a percent to have borrowed money. Rather than paying back 100% of a loan you might only pay back 99.5%.
This runs into what is called the zero lower bound. Loans to customers can’t make money at 0% or less, so even if the natural rate of interest due to deflation is lower than 0%, end user rates can’t go below 0. Maybe they can but no one really sorted out how to make that work.
Japan had negative interest rates because the expectation was that money would have more buying power later. If you had 1000 dollars just sitting in a mattress would buy more in future than it does today, you would wait to spend. And if you wait to spend and I wait to spend and no one spends the economy stagnates. Imagine you know a playstation is 500 dollars today, but will be 450 dollars next year. But rather than a playsration it’s everything, including business investments and government spending like roads and factories and so on..
Central Banks cut rates to encourage borrowing, since it makes it cheaper and lower risk for people to spend. Most of the west just spent almost 15 years with low rates after the dot Com bubble and then the 2008 financial crisis. But those rates all bumped into the problem of: if you are lending money at 0% interest, and people still aren’t buying things how do you get them to start purchasing? And then of course post pandemic we have seen a major run up in interest rates because the economy needed a major realignment post pandemic, that discussion will possibly be a whole new area of economic research though.
In Japan, having negative interest rates means that instead of earning money on their savings when they put it in the bank, people actually have to pay the bank to hold onto their money. It’s like a reverse situation where instead of getting a bonus for saving, you’re charged a fee.
This unusual situation is a strategy used by central banks to encourage people and businesses to spend and invest money rather than keeping it in the bank. By making it costly to save, they hope to boost economic activity and stimulate growth. It’s a bit like nudging people to put their money into the economy by making it less attractive to stash it away.
>but what does it mean practically speaking?
The Central Japanese Bank, the Bank of Japan, bought its own Long Term Bonds and even some private bonds in massive numbers.
I think there might be some misunderstanding, consumer banks most likely don’t have negative interest right just very low ones. It’s rather the central bank that does. What this means is that when banks create money, which they do by lending from the central bank they have negative interest on those loans. This encourages investment because the central bank encourages banks to spend and create more money. Sweden has had negative interest rates for most of the 2010s just recently increasing it to counter inflation.
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