IT SOUNDS like a contradiction in terms. But negative interest rates have arrived in several countries, in response to the growing threat of deflation. In June the European Central Bank (ECB) announced that it would pay -0.1% on the money banks deposited with it; in September the rate went even lower, to -0.2%. Denmark, Sweden and Switzerland also have negative rates. Banks, in effect, must pay for the privilege of depositing their cash with the central bank. Some, in turn, are making customers pay to deposit cash with them. Central banks’ intention is to spur banks to use “idle” cash balances, boosting lending, as well as to weaken the local currency by making it unattractive to hold. Both effects, they hope, will raise growth and inflation.

When an economy is struggling, the central bank usually cuts interest rates. The idea is to reduce the “real” (ie, inflation-adjusted) rate. As real rates fall, it becomes less attractive to save and more alluring to borrow. When real rates go negative, there is an extra potency: savers lose more money each year to inflation than they gain from interest. If saving is a losing proposition, investment and consumption should rise, buoying the economy.

As inflation falls, real interest rates rise. When the euro zone had 3% inflation and ultra-low interest rates, there was a negative real rate; now, with the main interest rate at 0.05% but inflation at -0.6%, the real rate is 0.65%. To get negative real rates, the nominal interest rate must be lower than the rate of inflation; if inflation is negative, the nominal interest rate must also fall below zero.

Economists have long assumed that, in practice, it would be impossible to send nominal rates below the “zero lower bound”. Cash is the sticking point. It earns interest of 0%. As soon as the rates banks offer fall below that, savers have an incentive to withdraw their money and stash it under a mattress (or in a safe-deposit box). But such is the seriousness of the situation that some central bankers are now willing to give negative rates a shot.

Advocates of negative returns point out that banks have huge sums stashed with central banks. These “excess” reserves—those above the minimum regulatory requirement—are the result of schemes such as quantitative easing (in which central banks print money to buy bonds, largely from banks). The Federal Reserve’s enthusiastic bond buying helped swell excess reserves in America from $1.9 billion in August 2008 to $2.6 trillion in January 2015. In the euro zone they climbed from €1.8 billion ($2.7 billion) in 2008 to €158 billion in 2013. Paying a negative rate on that pile would impose a nasty cost on banks. To avoid it, the theory runs, banks will lend more, thereby reducing their reserves.

In aggregate, the quest to diminish reserves is hopeless. As soon as one bank gets rid of some, by extending a loan to buy a car, say, the car dealer deposits the proceeds in another bank, boosting its reserves. But as banks try to palm these reserves off on one another, they increase lending, stimulating the economy. This whole picture, however, is dependent on finding lots of willing borrowers—something that is hard to come by when optimism about the prospects of new ventures is in short supply.

In fact, the downward march of nominal rates may actually impede lending. Some financial institutions must pay a fixed rate of interest on their liabilities even as the return on their assets shrivels. The Bank of England has expressed concerns about the effect of low interest rates on building societies, a type of mutually owned bank that is especially dependent on deposits. That makes it hard to reduce deposit rates below zero. But they have assets, like mortgages, with interest payments contractually linked to the central bank’s policy rate. Money-market funds, which invest in short-term debt, face similar problems, since they operate under rules that make it difficult to pay negative returns to investors. Weakened financial institutions, in turn, are not good at stoking economic growth. .

Other worries are more practical. Some Danish financial firms have discovered that their computer systems literally cannot cope with negative rates, and have had to be reprogrammed. The tax code also assumes that rates are always positive.

In theory, most banks could weather negative rates by passing the costs on to their customers in some way. But in a competitive market, increasing fees is tricky. Danske Bank, Denmark’s biggest, is only charging negative rates to a small fraction of its biggest business clients. For the most part Danish banks seem to have decided to absorb the cost.

Small wonder, then, that negative rates do not seem to have achieved much. The outstanding stock of loans to non-financial companies in the euro zone fell by 0.5% in the six months after the ECB imposed negative rates. In Denmark, too, both the stock of loans and the average interest rate is little changed, according to data from Nordea, a bank. The only consolation is that the charges central banks levy on reserves are still relatively modest: by one estimate, Denmark’s negative rates, which were first imposed in 2012, have cost banks just 0.005% of their assets.

Lump it or leave it

Indeed, the biggest effect of negative interest rates may be on currencies. Low interest rates help to pull down yields on all manner of local investments, encouraging both natives and foreigners to put their money elsewhere. As capital takes flight, the currency should fall. Since the ECB introduced negative deposit rates the euro has fallen against the dollar by nearly 20%. After Sweden adopted negative rates, the krona fell to a six-year low against the dollar. It is no coincidence that the central bank with the greatest enthusiasm for negative rates is Denmark’s: its sole objective is maintaining a fixed exchange rate with the euro.

Economist.com/blogs/freeexchange

* Studies cited in this article can be found at www.economist.com/negativerates15