The Consumer’s Definitive Guide: What To Know About Negative Interest Rates

Posted by Thierry Godard on March 10, 2016


If you’ve been following the news recently you might have heard the term negative interest rates being thrown around. Consumers and the media are equally terrified and confused about the issue, and rightfully so. Could Americans be forced to pay banks to safely keep our money, instead of the other way around? The anxiety surrounding negative interest rates is very real for the Japense consumer, so much so that home safes are literally flying off the shelves.

To say that the Bank of Japan has used negative interest rate policy (NIRP) to help jumpstart the Japanese economy with disappointing results would be an understatement. While the doom and gloom of it all does present a great opportunity for American schadenfreude, it is definitely a growing concern state-side. Especially after Federal Reserve Chair Janet Yellen stated in early February that the Federal Reserve was “taking a look at them...I wouldn’t take those off the table” in reference to negative interest rates.

Do Yellen’s words hold water? And more importantly, what does it mean for the American homeowner, credit card holder, or investor? Could negative interest rates wreak havoc on your personal finances?  

We spoke to a handful of financial industry experts, economists, and professors to get a clearer understanding of the issue surrounding negative interest rates, and the possible implications.

What are negative interest rates?

Negative interest rate, or negative interest rate policy, is when a nation’s central bank charges negative interest to encourage spending and stimulate the economy. For Japan it was a dire situation that came out of a decade of economic stagnation (it was really more like two) widely known as Japan’s lost decade.

Essentially the Bank of Japan set interest rates to negative in an effort to stimulate deflation of it’s currency. Investors saw this deflation as a return and continued to spend money- the balancing act kept the Japense economy from grinding to a complete halt. It goes without saying that the United States is nowhere near where Japan was when it enacted its negative interest rate policy.

Are there any similarities between the Japanese economy and what’s currently happening to the American economy?

Not really, the average Japanese and American consumer are drastically different. Much of Japan’s financial behavior was shaped by the difficulty faced post World War II, where many people were inclined to save their money rather than spend it. The Japanese economy has gone through “a 70 year shift, from a debtor nation to a very high creditor nation,” according to David Horner Chief Economist at Fixed Income Economy.  So the NIRP enacted by the Bank of Japan is really to get Japanese households to spend more of the money they have saved,  as well as curb economic stagnation in the face of larger socio-economic issues like an aging, and decreasing workforce.

“The American consumer is a one-of-a-kind, so I wouldn’t look to Japan as a guide.” Said Brain Koble, Director of Research at Wealth Management firm Hefren-Tillotson. The American appetite for debt is unrivaled elsewhere in the world and as a result, the American economy (and culture) has thrived with the exceptions of a few recessions. But Koble continued, “it’s not clear if consumers will ramp up borrowing even if interest rates fall even lower.  The wildcard are millennials, will they start families and buy houses and cars to the extent the baby boomers did?” The jury is still out, as many millennials continue to delay major “life milestones” en-masse.

So The Federal Reserve’s NIRP  could have larger psychological impact more than anything else. American consumers are unlikely to face negative interest rates directly,” said Tom Weary Chief Investment Officer at Lau Associates, “but a NIRP here would suppress overall interest rates- borrowers would benefit, and savers would continue to be penalized.” However, the effects of NIRP could spread and fester negative attitudes about the implied strength of the American economy, and employment prospects.

That said, many sectors of the economy are doing extremely well post Great Recession. Though banking and finance sectors seem to be struggling due to increased competition (thanks, fin-tech startups), and increased regulation. NIRP would likely hurt banks more than the people who bank with them, especially as the America  has begun to distance itself from big-banks.

What’s the worst that could happen?

For the vast majority of Americans not a whole lot would go wrong. If anything negative interest rates would be a huge plus to the American consumer's current financial lifestyle which has an appetite for borrowing heavily, establishing long-term investments, and saving less.

Horner was able to clarify exactly how, and why lower rates would benefit American borrowers. “Lower rates including negative rates are positive because they allow for refinancing debt at lower rates. Savers, not debtors are penalized.”

He continued, “ if the policy works as theory indicates lower policy rates now should result in higher market rates in the future as the economy recovers. This is another point that is often misunderstood. Both savers and borrowers receive or pay market rates, not policy rates.”

To put it more plainly, if negative interest rates as a policy would definitely drag down market rates, but they’re unlikely to go negative as well. The upside is that consumers could benefit greatly by refinancing a lot of their debt during historical low periods and to hedge against higher interest rates in the future.

For current and aspiring homeowners the news gets even better. “Mortgage interest rates come down as much a one full percentage point,” according to Professor John Edmunds of Babson College,  “especially for floating rate mortgages which are priced off of short-term government bonds, that are going to have very low interest rates of under 1%.”

This could translate to a 2% mortgage rate for consumers which means it would make a lot of financial sense for many Americans to afford a house, qualify for great terms, refinance at great rates, renovate their homes, and sell their homes at a profit due to increased demand. If the Federal Reserve does enact negative interest rate policy we could be on the verge of a real estate boom driven by ultra-low interest rates, sound consumer credit, and investors turning to high quality mortgage backed securities as a source of revenue.

But these are all hypothetical situations based on economic and monetary theory. Some ambiguity exists about whether or not it’s actually possible for the Federal Reserve enact negative interest rates. Doing so would likely require Congress, and The White House to work together in supporting The Federal Reserve’s policy change. Long-story short, the fed going negative is a very long,  drawn out, possibly politically contentious, conversation that no one really wants to have in the middle of a presidential election year.

So the better question is: why is negative interest such a big deal all of a sudden? Is it big banks fear mongering, or do consumers actually have something to look forward to?

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Topics: Mortgage 101, Credit & Debt, Personal Finance

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