Less Than Zero

When Interest Rates Go Negative

ECB President Mario Draghi Announces Interest Rate Decision

Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero. For some, it’s a bid to reinvigorate an economy with other options exhausted. Others want to make their currencies less attractive to own. Either way, it’s an unorthodox choice that could backfire.

The Situation

The European Central Bank cut a key interest rate below zero in June, becoming the first major central bank to venture into negative territory. It wants to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery. The bank cut its deposit rate twice, reaching minus 0.2 percent in September, when President Mario Draghi said interest rates were at the “lower bound.” A deposit rate below zero effectively punishes banks that have extra cash but are reluctant to extend loans to weaker lenders. The euro zone is is grappling with a shortage of credit and unemployment near its highest level since the currency bloc was formed in 1999. The ECB has particular reason to use negative interest rates. The U.S. Federal Reserve and the Bank of Japan have turned to large-scale asset purchases, known as quantitative easing, that create new money to fuel the recovery. European Union rules make it politically difficult for the ECB to buy large volumes of government bonds, though it’s considering such a move. In December, Switzerland imposed its first negative deposit rate since the 1970s to keep expectations for more ECB stimulus and the Russian financial crisis from driving up the Swiss franc.

Source: European Central Bank
Source: European Central Bank

The Background

Negative deposit rates have been used by a handful of smaller central banks in recent years, including Sweden’s, which cut its deposit rate below zero again in July in an effort to boost prices. Denmark returned to a negative deposit rate in September, though the cut was aimed at protecting its currency rather than stimulating growth. There is no guarantee that negative rates will be able to revive an entire economy or work in one as large as the euro area. During the height of Europe’s sovereign debt crisis two years ago, Draghi pledged to do “whatever it takes” to save the area’s common currency, signaling the ECB’s willingness to experiment with monetary policy.

The Argument

In theory, an interest rate below zero should lower all market rates, thus also reducing borrowing costs for companies and households. In practice, though, there’s a risk that the policy might do more harm than good. Janet Yellen, the Fed chair, said at her confirmation hearing in November 2013 that the closer the deposit rate is to zero, the bigger the risk of disruption to the money markets that help fund banks. (The Fed pays 0.25 percent on excess reserves.)  In Denmark, commercial banks aren’t passing on negative rates to depositors for fear of losing customers.  When banks absorb the costs themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend.

The Reference Shelf

  • Blog posts from Francesco Papadia, a former director general for market operations at the ECB, on whether the central bank should have negative rates, and a discussion about where rates could go.
  • A May, 2014 interview with Peter Praet, a member of the ECB’s executive board on policy options published in Die Zeit.
  • A speech by Benoit Coeure, a member of the ECB Executive Board, on monetary policy and the challenges of the zero lower bound.
  • A Bloomberg News article outlining the pros and cons of a deposit rate of zero or below and a QuickTake on the ECB’s options for some form of quantitative easing.
  • An ECB research paper on non-standard monetary policy.
  • A paper by Charles Goodhart, a former member of the Bank of England’s Monetary Policy Committee, arguing a negative rate on excess reserves would depress sovereign bond yields.


First Published Dec. 5, 2013

To contact the writer of this QuickTake:

Jana Randow in Frankfurt at jrandow@bloomberg.net

To contact the editor responsible for this QuickTake:

Paul Gordon at pgordon6@bloomberg.netLeah Harrison Singer at lharrison@bloomberg.net