Negative interest rate policy (NIRP) is one of many monetary policy instruments implemented by central banks. Negative interest rate has been used to combat concerns surrounding slowing growth and inflation.
This policy, which is generally used in addition to monetary expansion is mostly supported by forward guidance, aims to increase the volume of liquidity in circulation and stimulate domestic demand as well as inflation.
In practice, central banks apply negative interest to the money they hold in their current accounts, with the aim of converting the money into loans instead of the current account.
Along with this, it is expected that as the increase in credit growth increase adds to domestic demand. The said loans also revitalize trade by directly lowering company borrowing costs.
The negative interest rate policy is generally perceived as a monetary policy management that globally fosters economic vitality by supporting demand for developing countries’ assets. Due to a consequent decline in bond interests, negative interest rates in developed economies increase the demand for assets in developing countries.
Japan, a developed country that has been in recession for much of the 2010s, started to implement negative interest rate policy in 2016. Thanks to this decision, commercial banks have had to pay an interest rate of -0.10% for the liquidity they hold at the deposit accounts of Bank of Japan. The policy goes on as of 2019.
Similarly, Switzerland, Denmark and Sweden keep the policy rate at a negative level, while the European Central Bank keeps deposit rates at the level of -0.40%.
Such a policy leads to devaluation in the currency of the country and theoretically puts it in an advantageous position especially in terms of export. However, considering the current economic situation, a slowdown in commercial transactions due to lower demands has also limited that advantage, by overriding a central bank’s move to devalue the currency.
On the other hand, if the negative interest rate policy is used along with monetary expansion to stimulate domestic demand, it leads to appreciation rather than the desired depreciation due to a lack of new investment opportunities and windows in the over-saturated economy. That, for example, is the case in Japan.
As an example, we can see the annual openings of the Japanese Yen versus the US Dollar in the graph showing the appreciation since the policy began to be implemented in 2016.
Negative interest rates also raise the appetite for risk in the markets. Thanks to this tool, savings owners and companies can borrow much higher amounts of credit than they can hardly pay otherwise. This, then, is reflected negatively in the net profitability of banks.