President Donald Trump again lambasted the Federal Reserve, tweeting on Wednesday morning that the "boneheads" at the central bank should slash interest rates to "ZERO, or less" to boost the economy.
To many, negative interest rates seem like a financial world turned upside down. But the president is not the only person to float such a policy.
Former Federal Reserve Chairman Alan Greenspan said last week that it's "only a matter of time" before negative rates reach the U.S., and JPMorgan Chase CEO Jamie Dimon said on Tuesday that while he doubts the U.S. will turn to negative rates, his bank is nonetheless preparing for such a possibility "just in the normal course of risk management."
After the financial crisis in 2008, central banks in many countries cut their interest rate to near-zero levels. That left them with little wiggle room for further rate cuts, prompting some countries to opt in recent years for a negative interest rate, where the borrower pays the issuer. It's essentially a way to discourage financial institutions from stockpiling cash at the central bank.
"We had a freeze-up in our credit systems [after the Great Recession]," said Robert Phipps, director of wealth and capital management firm Per Stirling. "Banks wouldn't even lend to each other." Without money available, companies couldn't invest, people couldn't borrow for purchases, and much economic activity stopped.
Lack of demand drove lower prices, causing people in turn to put off purchases as they waited for even lower prices. Companies lost business and laid off workers. Such a deflationary spiral ultimately "leads to [a] depression," said Jeffrey Bergstrand, a finance professor at the University of Notre Dame and former Federal Reserve economist.
"The pressure for central bankers to step up for a time of extreme crisis, to fight it with all available means and even invent new ones, is a temptation," said Daniel Smith, an associate professor of economics at Middle Tennessee State University.
Part of what central banks do is act as repositories for the cash reserves of commercial banks, which typically get paid interest on the reserves by the central banks. Because of enormous uncertainty during the collapse, commercial banks kept money in reserves to get some guaranteed income and safety.
By offering negative interest rates on reserve deposits, central banks hoped to pressure commercial banks to lend money instead, helping to restart the economy.
Short-term government bond rates, which tend to follow central bank rates, also dropped below zero. "Negative interest rates ostensibly should encourage investing in riskier assets instead of safer assets, which by textbook should supply stimulus," said Tom Graff, head of fixed income at investment management firm Brown Advisory. People and institutions would buy corporate bonds with higher interest rates, providing the money companies needed to operate and expand, again helping the economy move the needle.
At first, negative interest rates — along with so-called quantitative easing, in which central banks bought government bonds and other assets from banks to inject capital — seemed to do some good.
"They stabilized the financial system, which was in great stress," said Tapan Datta, head of asset allocation at risk, retirement, and health services firm Aon. "They got a modicum of growth going."
"Putting money into the system did help because it helped calm the panic," said Todd Knoop, economics department chair at Cornell College. "A lot of this is about confidence."
The EU and Japan kept negative rates in place, hoping for further stimulus — an effort that ultimately fizzled, given the slowing economies of those regions. A recent study from the University of Bath suggested that negative interest rates could even lead to weaker bank lending by going too far to the other extreme.
For U.S. consumers, a zero-percent interest rate would erase any gains in savings, but barely make a dent in their revolving debt, such as credit cards or car loans. However, it would have an outsize impact on mortgages, with the traditional 30-year fixed rate loan already at near-historically low levels.
If a recession does come, it also means the Fed has less room to stimulate the economy because rates are already very low. That might make things look pretty negative after all.
