Throughout the year, economists and market analysts have been speculating about the potential for the Federal Reserve to take extraordinary steps in the face of the COVID-19 pandemic. Similar discussions have been taking place regarding the Bank of England as well. One such suggestion that has gained traction has been for the Fed (and, across the pond, the BoE) to set negative interest rates.
At first glance, a negative interest rate might seem counterintuitive or even just flat-out impossible, but this unconventional financial tool actually does exist.
Let's examine how a negative interest rate operates, and how it impacts the economy, including consumers, small-business owners and those saving for retirement.
How Fed's interest rates work
The concept of a negative interest rate is a relatively recent phenomenon, first appearing in different parts of Europe following the 2008 global financial crisis.
In the U.S., the Federal Reserve can establish a negative interest rate in one of two different ways. The first allows the yield for bonds and Treasury securities to go negative. The other involves the federal funds rate, the Federal Open Market Committee's (FOMC) target interest rate at which commercial banks borrow and lend their excess reserves to other banks overnight.
When the Fed raises its rates, taking out a loan costs more, and when it lowers the rate, it becomes less expensive to take a loan. The underlying purpose of raising or lowering the rate is to maintain stable economic growth.
Currently, the Fed has not set a negative interest rate, although the target rate sits at 0-0.25%, as low as it possibly can go without turning negative.
What negative interest rates mean for the economy and consumers
While this might not seem relevant to the average person, a negative interest rate may have consequences that impact consumers, small-business owners and those saving for retirement.
If the Fed set a negative interest rate, banks holding money in Federal Reserve accounts would be charged a fee. These banks would transfer the policy rate on consumer products, like loans or mortgages.
Setting its federal funds rate in negative territory would mean that, theoretically, customers will have to pay a bank to hold onto their money, instead of the bank paying interest on a savings account or a certificate of deposit (CD). Conversely, taking out a loan to buy a home or a car would entail these customers to earn some money with negative rates instead of having to pay interest on the loan.
Ideally, economists and market analysts believe, a negative interest rate can incentivize greater borrowing and spending that would increase inflation to a target range. The idea being that borrowing money itself creates a profit, and banks would be more willing to lend, otherwise they'd have to pay for holding the money with the Fed.
For now, a negative interest rate for the federal funds rate is not a reality and looks unlikely for the U.S. economy. But with the rate currently sitting at zero, the Fed has little room to maneuver if it needs to do something drastic to maintain economic stability.
Reach out to The Federal Savings Banktoday to learn more about negative interest rates.
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Now, let's delve into the concepts mentioned in the article:
1. Negative Interest Rates:
- Negative interest rates are a relatively recent phenomenon, gaining attention in Europe after the 2008 global financial crisis.
- This unconventional financial tool involves setting interest rates below zero, essentially charging depositors to hold their money.
2. Federal Reserve's Interest Rates:
- The Federal Reserve (the Fed) has the authority to establish negative interest rates through two primary mechanisms:
- Yield for bonds and Treasury securities can go negative.
- The federal funds rate, the target interest rate at which commercial banks lend and borrow excess reserves overnight.
- The Fed adjusts interest rates to influence borrowing costs, impacting spending and economic growth.
3. Current Fed Policy:
- The article mentions that the current target rate set by the Fed is 0-0.25%, indicating the lower bound of interest rates.
4. Impact on Banks:
- If the Fed sets a negative interest rate, banks holding money in Federal Reserve accounts would be charged a fee.
- Banks might transfer the policy rate to consumer products like loans or mortgages.
5. Impact on Consumers and Businesses:
- With a negative interest rate, consumers might have to pay banks to hold onto their money.
- Conversely, borrowers could earn money with negative rates when taking out loans for purchases like homes or cars.
6. Economic Incentives:
- Economists and market analysts believe that negative interest rates can incentivize greater borrowing and spending, potentially increasing inflation to a target range.
- The idea is that borrowing becomes more profitable, encouraging banks to lend rather than incur costs for holding excess reserves.
7. Economic Stability and Monetary Policy:
- The article discusses the Fed's role in maintaining economic stability and how a negative interest rate could be considered if more drastic measures are needed.
8. The Federal Savings Bank:
- The article concludes by encouraging readers to reach out to The Federal Savings Bank to learn more about negative interest rates, suggesting a practical application of the discussed concepts.
In summary, the article explores the possibility of negative interest rates, their potential impact on various economic stakeholders, and the current state of the Federal Reserve's interest rate policy.
