Negative Interest Rates — What Does That Really Mean?

by | Jun 23, 2016 | Personal Finance 101 | 0 comments

Macroeconomic policy, though it seems very far-away to the typical citizen, is actually incredibly important not just to the national economy as a whole, but to your wallet and household finances. Policy decisions — especially from the Federal Reserve’s funds rate — spill through the economy and will have repercussions on your day-to-day life. One of the policy options being considered in the U.S. (and presently in place in Japan and the European Union) is NIRP (Negative Interest Rate Policy). So what does that mean, really?

Investopedia defines NIRP as:

A negative interest rate policy (NIRP) is an unconventional monetary policy tool whereby nominal target interest rates are set with a negative value, below the theoretical lower bound of zero percent.

In simpler terms, this means that NIRP is where interest rates are set at a negative value. Therefore, when a bank charges interest in a NIRP world, that interest rate will be negative. Though the Federal funds rate really only applies to the central bank, other private banks may well follow, because they, too, are impacted by the Fed’s benchmark interest rates.

For example, if you were to go to the bank and deposit $100,000 at a -2% interest rate, after a year, you would be left with $98,000; this is in contrast to a +2% interest rate, where your money would grow to $102,000 at year’s end.

In the U.S., there have never been prolonged periods of negative interest rates, but some leaders are considering them now. But why?

Negative interest rates would disincentivize¬†people to save money in banks — after all, you’re losing money. The intended consequence of this is that people would go searching for financial products with higher rates of return — the stock market. And that would help prop up U.S. businesses. However, a potential other outcome is that people simply hold cash and store it under their pillow, rather than investing it.

NIRPs are becoming more common in the public discourse, and it is important to know what they might mean for you. If you have any questions about NIRPs or other financial questions, simply contact your wealth strategist.