Analyzing the Effects of Negative Interest Rates

The modern economists are not satisfied with the current economy and especially the annual growth rate. Despite higher GDP per capita in the western countries, there are too many people who are not satisfied by the wealth distribution in the society (The rich get richer and the poor get poorer) and this could go to social unrest. Massive debt in western countries combined with low annual growth (low growth of wages) radicalizes more people and they are looking for a solution in parties with far-right or populist ideology. If they take power, they will threaten the democratic foundations of our society and probably will destroy/put restrictions on the free market system converting it, in more state control economy or even will try to copy the Chinese model (State control economy).

Politicians know that if they don’t find a solution for the people’s demand, it will put our society at risk. One of this possible solution is negative interest rates–the idea is, if our banks use negative interest rates (they will charge us our money in the bank), this will stimulate people to withdraw their money and investing them back in the economy-launching a new business and investing in Stock market. Does this policy will boom the economy or it will doom it?

The current economic model of Central Banks is to support low-interest rates to stimulate economic growth and borrow money… the side effect is that this increases the value of assets (property and stock market) and creates an ideal scenario for the next bubble. With higher property prices, they become inaccessible for the majority, favoring only few owners… and we all know what happens when the bubble bursts… the effect is devastating for the whole economy and can lead to recession… Another one and social instability follow. Therefore, this is obviously, not the perfect model, but do you have a better one?

Some economists think that they had already found it-the solution to our current economic problems (low growth and high debt) are negative interest rates. But how are they working, and what does it mean for the average person? If you have a deposit in the bank, instead of receiving an interest rate on it, you will have to pay to the bank for the luxury of keeping and holding your “clean and safe “money. Let’s give an example–you take a $1000 loan with 3% an annualized interest rate- you will pay the amount that you negotiated with your bank plus 3% interest or $30 per year-with negative interest rate, you again pay your amount, but instead to have $30 interest per year (3%), the bank will pay this sum… sounds too good to be true? But if we speak frankly, it is a reality in some countries.

In 2019, in Denmark, the local bank (Jyske Bank) was the first one to introduce a mortgage with a negative interest rate (0.5%), wherein the end, you will pay less money than you received.

But if you don’t use the loan, you don’t spend, you like to save you money at the bank- I have bad news for you-the bank will charge you money for this, and at the end of the year, you will have less money-the percentage is small (.0.5%), but there are suggestions to be increased, to stimulate people not to save, but to spend and invest.

If you have an old loan-I have good news for you-you can negotiate and replace your old loan with the new one at a cheaper rate. It doesn’t sound very fair, if we compare two types of men, one with a good credit score and one with a bad one-is it possible to return the effect of NINJA loans in the economy(one of the reasons for the economic crisis (2007–2008) and if they offer negative interest rates, how they will make a profit?

But how the negative interest rates will affect government bonds. Does this mean that you must pay negative interest rates every year? No, you will pay nothing, but because of the negative interest rates, your return will be negative instead of positive.

If we speak frankly, there are several changes, before considering implementing the negative interest rates worldwide:

-How will the bank make money?

Banks are profitable organizations-they need to make a profit to survive and thrive. Even if the interest rates are low, they still make money, but how they will make money, if they pay interest rates, instead of its customers?

One of the solutions is to charge more fees and taxes to its customers; selling other services like different kinds of insurances. Also, negative interest rates have a benefit for them too-they will receive funds from their depositors (they will be charged annually with negative interest rates).

Also, adopting the strategy of negative interest rates is not a strategy of the local banks, but the Central Bank of the country to fight deflation(which can sound tempting-the prices decrease; the price of the properties drop, but causes many economic problems) and stimulates economic growth if the economy is close to stagnation. Therefore, the local banks may be compensated additionally from the Central Bank.

-Will the people keep their money at the bank?

If you are charged with a negative interest rate, if you are a depositor, you have an incentive to take the money from your bank and put it in some other places to stop the loss of money-it can be some financial instruments(which can be risky) or to use the old fashion way- keep their money under the mattress. This mass withdraws can lead to chaos in the banking system (banks don’t have 100% of the money of their depositor and savors, but a small fraction of it) and the total crash of our financial system.

Central banks are relying that storing money is costly and risky, and the majority will choose to keep their money safe. Also, the negative interest rates wouldn’t be too low. Losing -2% or -3% annually is not a big loss, so Central banks are considering, that the people will keep the money at the banks.

-Make banks more selective

Cutting the profits of the banks means that their initiative for landing would drop. They will not give loans to the people so easily and willingly to lend less. They would be more selective-the clients with solid credit ratings will not suffer, but the people with less than excellent credit rating would.

If the banks are not stimulated to give more loans, the lending will suffer and the economy as well.

-Devaluation of the currency

Using negative interest rates will lead to the devaluation of the currency. This is good for the export and the export industry will boom, but weaker currency will lead to more expansive imported goods, so it will hurt the purchasing abilities of the population (mainly importing goods and services).

-Creating new bubbles.

OK, let’s imagine, we discover a solution to stimulate the banks to give loans and they offer loans in the maximum capacity or risky crediting (at the end, this is the idea of negative interest rates-to stimulate lending, spending and investing)… but can this lead to a new asset and house bubble-the price of the houses would cost too much and they would be not affordable… and when the bubble bursts… we will have a devastating impact on the economy.

-Currency wars

Therefore, we use negative interest rates, devaluating the currency with the primary goal to stimulate export. In the end, this is working, the economy is booming because of the strong export. But what if the other countries try to replicate this model and make the same-they devaluate their currency with purpose too… this will lead to currency wars-which country will devaluate their currency the most… and the currency war can lead to a real one?

To the surprise of many, we have real examples of negative interest rates-some of the countries adopt some component of it and we can see, is this working or not?

Sweden was the first one to adopt this monetary tool. In July 2009, Swedish Central Bank cut the deposit rate to -0.25%… then followed by European Central Bank, Switzerland, and Japan, which means that now government debt is carrying negative yields.

We are curious to examine what is the performance of Sweden. Be caution, that at the end of 2019 (10 years later), Sweden ended this experiment[1], when the Central Bank of Sweden rose the interest rate from -0.25% to 0%.

Let’s see what is the performance of Sweden for the last ten years.

-SEK to USD

As we mentioned above, when we use a negative interest rate, we instantly experienced a devaluation of the currency. Later, we see SEK became stronger[2](probably because of strong export), but from 2014 became weaker and weaker. SEK devaluated with 17.66% [3]

So, we can conclude that the negative interest rate devalued your currency.

We are very curious to see the export figures for Sweden-as this is the main idea of a negative interest rate.

-Export

With the intention, we include the export of Sweden for a more extended period, starting since 1995. The export was expanding even during the Economic crisis (2007–2008), but slow-down in 2009(before introducing negative interest rates). From the end of 2009 started to increase and from the beginning of 2010, it started to accelerate. It is not a magic pill but helped for the export.

-Export as a percentage of GDP

The better picture is to analyze the export as a percentage of GDP. The peek was in 2008 with 49.47% of GDP. In 2009 we had a sharp decrease to 44.41%. After implementing negative interest rates, we have a sharp increase to 46.13% in 2010. If we see the big picture (the difference between 2009 and 2018) it is tiny- 44.41% (2009) vs 47.04% (2018) [4].

The new policy of the Central Bank of Sweden didn’t help to reach the maximum level of 2008 (49.75 %)

-Annual growth

When we analyze the data, we see that the average annual growth from 2000 to 2009(before introducing negative interest rates) is 2.13% [5], but the average annual growth from 2000 to 2019 rose to 2.49 %.

Not an enormous difference. A year after launching the negative interest rates, we enjoyed very good growth (6.2% in 2010) but later reduced to reach on average 2.4% (between 2016–2018), until reaching 0.9% in 2019.

Maybe this slow growth was one of the reasons to be abolished.

-Sweden House Price Index

“A picture is worth a thousand words”-old phrase, but classic. You can see the difference between 2009(when the negative interest rates were implemented) and 2019(when they were abolished). The house price index went from 120 (2009) to nearly 240 (2019). As we mentioned earlier in this article, one of the fears of this new policy is that it will increase the prices of the property significantly… as we can see- without any doubt, this statement is correct.

-Sweden Private Debt to GDP

Sweden’s private debt as expected increased too -from 262% to nearly 280%. For comparison, the private debt of Greece is only 123% and during the worst crisis, where Greece was close to default, the maximum private debt has risen to 148.3%.[1]

Conclusion

The negative interest rates sound extremely good to be true- there are too many hidden bombs that can and unfortunately will explode. We have an excellent example of Sweden-a country that implied a negative interest rate in the middle of 2009 and used it for ten years until 2019 when the Central Bank of Sweden has risen the interest rates to 0%. This period is enough to analyze, is this model is working or not? If we summarize, it does not impress us with the results. Some of our predictions were accurate, others not so much… but we didn’t see something fascinated about the results of Sweden. The SKR was devaluated (as expected), at the first look, the export was booming, but we analyze export as a percentage of GDP, the increase is tiny 44.41% (2009) vs 47.04% (2018); the difference in the annual growth is only 0.36 %.

Now the bad news is coming-the house price index almost doubled- from a little over 120 to nearly 240, the private debt increases too, reaching nearly 280% of GDP… over two times larger than the private debt of Greece (the country that was closed to declare default).

Most likely, these were the key reasons, Sweden Central Bank to abandon this experiment.

Do negative interest rates work? If we take Sweden as an example, the answer is no.

Source:

[1] https://uk.finance.yahoo.com/news/amid-housing-bubble-sweden-swedish-central-bank-riksbank-ends-negative-interest-rates-131528923.html available 01/2020

[2]https://www.xe.com/currencycharts/?from=SEK&to=USD&view=10Y available 01/2020

[3]https://www.investing.com/currencies/sek-usd-historical-data available 01/2020

[4]https://www.theglobaleconomy.com/Sweden/exports/ available 01/2020

[5] https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/SWE available 01/2020

[6] https://tradingeconomics.com/greece/private-debt-to-gdp available 01/2020