Thursday, June 05, 2014

Europe Gets Negative Interest Rates. What Does That Even Mean?

Neil Irwin, NYT
JUNE 4, 2014

First there was ZIRP. Now get ready for NIRP.

The first is “zero interest-rate policy,” the strategy for trying to stimulate economic growth that the United States has undertaken for the last 5 ½ years (and the Bank of Japan much longer than that). The second is “negative interest rate policy.” And that’s what the European Central Bank put in place on Thursday for the 18 nations that use the euro currency.

That makes this a good moment for the curious mental exercise of pondering what a negative interest rate even means, and why it’s something that monetary policy mavens have been talking about more than they would like over the last half-decade.

What is a negative interest rate?

When a bank pays a 1 percent interest rate, it’s clear what happens: If you deposit your money at the bank, it will pay you a penny each year for every dollar you deposited. When the interest rate is negative, the money goes the other direction.

We’re talking about central banks here, but the same notion applies. Commercial banks maintain their reserves electronically at a central bank, like the Federal Reserve in the United States or an arm of the European Central Bank in Europe. In normal times, they are paid an interest rate set by the central bank for reserves they keep on deposit beyond what is needed to meet regulatory requirements. If the E.C.B. moves to a negative interest rate, they will instead have to pay the central bank to park money there.

(More here.)

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