Breaking the Norm: Understanding Negative Interest Rates

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Negative interest rates or Negative Interest Rate Policy (NIRP) have emerged as a powerful tool in the realm of monetary policy, defying traditional economic norms. While unconventional, these rates have gained more attention among central banks in recent years. Negative interest rates are not uncommon. If the inflation rate exceeds the nominal interest rate, the real interest rate would be negative, meaning that people would lose money if they are saved in the consumer deposits. However, in this article we look at nominal interest rates being negative. The introduction of negative interest rates gained prominence after the global financial crisis, where central banks facing economic downturns, had slashed their interest rates to near zero levels, in order to stimulate spending. 

With economies still struggling in the years that followed, policy makers in the Euro zone, Switzerland, Denmark, Sweden and Japan allowed rates to fall below zero. In 2012, Denmark became the first country in the world to impose negative interest rates. The European Central Bank (ECB) and the Swiss National Bank (SNB) introduced negative rates in 2014, followed by the Bank of Japan (BOJ) in 2016. It is important to note that the negative rates were implemented on the deposits on excess reserves, which is the interest rate that the Central Bank offers commercial banks for holding cash.  Under a NIRP, banks and other financial institutions are required to pay interest for parking excess cash with the central bank, aiming to discourage saving and encourage lending to boost business activity which is similar to a conventional fall in the policy interest rate. This would trickle down to affect all other saving accounts within the economy. A negative interest rate, in theory, would likely mean consumer savings accounts will have their returns plummet to zero and may even experience a negative interest rate. However, banks are wary of passing negative interest rates to customers and will more likely choose to absorb the cost without letting consumer deposit rates dipping below zero, in order to prevent consumers from purchasing other products, or worse – a run on the bank. 

The Borrower's Advantage

A peculiar aspect of negative interest rates is that they can potentially lead to a scenario where banks pay borrowers to take out loans, resulting in borrowers paying back less than they were originally loaned. While this may seem counterintuitive, in practical terms, banks have often raised other fees associated with the loan to nullify the negative interest rate and the effective interest rate remains positive. However, there have been rare instances where negative interest rates have translated into negative effective interest rates for borrowers. In 2019, Jyske Bank, a Danish bank, made headlines by offering a 10-year mortgage with an interest rate of -0.5%. In this scenario, eligible borrowers with secure financial positions and low loan-to-equity ratios could effectively repay an amount lower than their initial borrowing[1]. This occurrence was a rare exception where the effective interest rate turned negative.

Why Go Negative?

If interest rates are already at its zero-lower bound, negative interest rates can be seen as a last and desperate option for Central Banks to spur borrowing and spending to push inflation back to target levels, especially when if the economy is experiencing deflation. When a NIRP was imposed in the Euro Zone, Denmark and Japan, they were struggling with chronic slow growth and deflation. Deflation can be bad as consumers hoard their money rather than spend it since a dollar tomorrow is worth more than a dollar today. This can lead to a vicious cycle and prompt declines in spending as consumers postpone consumption in hopes that prices will fall further in future. Hence, negative interest rates can be seen as a way of discouraging this situation. 

A NIRP can be used as a way of devaluing a country’s currency which can stimulate the price competitiveness in the export sector. It causes an outflow of hot money as foreign investors are driven out, thus depreciating the currency.  The BOJ went negative in 2016, mostly to prevent a strengthening of the Yen from hurting its export-heavy economy and after its implementation, the Yen saw an immediate depreciation. The Euro also saw a strong depreciation and in Denmark and Switzerland the appreciation of their respective currencies were halted by the introduction of negative rates.

Unintended Consequences

Negative rates could cut profitability of banks as they would have to pay for their deposits at the central bank, reducing their interest margins between savings and lending rates. Some research suggests that a NIRP has actually decreased lending as it adversely affected banking profits[2]. In instances where the interest rates on deposits are negative, it may cause households and businesses to hoard cash rather than spend, preferring to fiscally store their cash rather than keeping them at banks and incurring a cost. Japan and Germany saw an increase in sales of safes following the implementation of NIRP[3]. Negative interest rates also pose challenges in selling new government debt issues when yields are negative. Germany, for instance, encountered difficulties in August 2019 when it attempted to raise €2 billion through 30-year government bonds with negative yields and only managed to raise €824 million[4]. Furthermore, a prolonged period of very low or negative interest rates may contribute to the survival of “zombie firms”. These are companies that would typically have ceased trading but continue to operate by rolling over debt at low or negative interest rates. The issue with such firms is that they generate just enough profits to sustain their operations without the necessary innovation or investment required for long-term growth which can hinder an economy’s productivity[5].


Negative interest rates are a relatively new phenomenon that we still don’t fully understand, given the small sample size that have implemented them and the lack of historical data available. It represents a radical departure from traditional monetary policy measures, and their implementation has sparked debates among economists and policymakers. While they have the potential to stimulate borrowing and investment, their effectiveness is not guaranteed, and they may have unintended consequences. It is crucial to view negative interest rates as a last resort, to be employed only when conventional policy tools have proven inadequate in addressing deflationary pressures and promoting economic growth. As Harvard Professor of Economics, Ken Rogoff, aptly states, “You just don’t do this on a normal sunny day”.

By Trent Hemachandra
Research Associate 
The Ceylon Chamber of Commerce

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