The RBA is now considering the drastic measure of negative interest rates — meaning you could be paid to borrow money from the bank

Jack Derwin| Business Insider| 12 August 2019

https://www.businessinsider.com.au/the-rba-is-now-considering-the-drastic-measure-of-negative-interest-rates-meaning-you-could-be-paid-to-borrow-money-from-the-bank-2019-8

Australians could soon be paid to borrow money from banks for the first time in history, as the Reserve Bank of Australia (RBA) says it’s prepared to take extraordinary steps to stimulate the economy.

Facing up to the government’s standing economic committee on Friday, RBA governor Phillip Lowe said the central bank was now considering “unconventional” methods to get the country moving again.

“It’s possible that we end up at the zero lower bound. I think it’s unlikely, but it is possible. We are prepared to do unconventional things if the circumstances warranted it,” Lowe said.

Lowe admitted that includes the possibility of slashing the official interest rate — currently at 1% — to below zero, an unprecedented measure in Australia despite beign implemented abroad.

“When we look overseas, we see some central banks have very low-interest rates and some countries have negative interest rates. In Switzerland right now the interest rate is -0.75%, in the euro area it’s -0.40% and in Japan it’s -0.10. So some central banks have gone negative. That’s one possibility,” Lowe said.

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But what would that actually mean?

Historically the RBA, and most other central banks, has always kept interest rates positive. When individuals leave their money with a bank for example, the bank pays interest on that deposit.

Banks and other financial institutions then lend that money out, charging a larger interest rate to borrowers. The difference in interest rates is how institutions like banks make a large portion of their profits.

As interest rates get lower, individuals receive less interest on their deposits and pay less on what they borrow. That typically leads to greater spending as mortgages and other loans become cheaper and money sitting in the bank doesn’t earn customers much at all.

When the interest rate enters negative territory, however, the tables get flipped completely and everything gets a little topsy-turvy.

Negative interest rates mean that money deposited with a bank can be charged interest instead of earning it. Even more radical is the fact that banks can actually pay individuals to borrow money.

For example, if the interest rate here was cut to -2%, theoretically: An Australian with a $100 loan from a bank would be paid $2 for every year they held the loan. An Australian who left $100 in a bank and didn’t touch it would have $98 at the end of the year (which could see people stuff their mattresses with cash instead).

Accordingly, negative interest rates are intended to encourage spending even more than low positive interest rates. That because customers are charged money on their savings and paid to borrow instead of the reverse.

In turn, a country’s currency is meant to be weakened by negative rates, boosting exports which should help the economy along even more.

However, that’s all in theory. In practice, negative interest rates have a chequered history.

As of 2016, this has been the effect of negative interest in the countries it had been tried, according to Bank of America- Merill Lynch.

With the exception of Sweden, which saw a modest improvement, the other economises actually worsened, leaving the track record of negative interest rates unproven.

That’s partly why Lowe made reference to negative interest rates and other unconventional methods as being on the table in the longer term rather than the RBA’s next move.

“I’m not thinking that any or all of those would be appropriate in Australia. There are some lessons, though, that we’ve drawn,” he said.

However, despite the possibility that a negative interest rate can actually hurt an economy, it doesn’t seem to be discouraging countries from experimenting with them.

Just last week a Danish bank began voluntarily offering home loans at a -0.5% interest rate, meaning customers pay back the bank less than they borrow.

For example, customers who buy a house for $1 million and paid off your mortgage in full in 10 years, would only pay the bank back $995,000.

While it sounds counter-intuitive, the rationale is that banks are happier to make a small guaranteed loss than a much larger one in case of customers defaulting when they can’t make higher repayments.

Plus, 10 years of bank fees probably sees a small profit turned in the end.

Whether or not it boosts Denmark’s economy is another matter altogether.