Negative Interest Rates: Definition & History

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

Strange as it sounds, a negative interest rate means that you end up having to pay a bank in order to store your funds. Additionally, it means that borrowers get paid. Learn how negative interest rates started in this lesson.

Definition

By definition, a negative interest rate is an interest rate where the borrower gets paid and the person who deposits money must pay to deposit it. It is a really weird concept that does not easily make sense. But for the central banks of some countries, it is a very important concept as it may be the key to spurring the economies of those countries. Each government has a central bank and commercial banks have an account with the central bank of the country they are in. This allows commercial banks to move money around from point A to point B. So think of the central bank as the bank for commercial banks while commercial banks are for people like yourself.

To give you an example of a negative interest rate, picture yourself going to the bank and asking to open up a savings account. Usually, if you open up a savings account, you know that your money will grow by a certain percent each year. Like if the interest rate is 5 percent, then each year, your money will grow by 5 percent. But this time around, your bank tells you that your interest rate for opening up a savings account is now negative 5 percent. What in the world? This means that instead of you earning 5 percent extra each year, you now have to pay 5 percent to the bank just for saving your money there. Strange, huh? You would probably say forget it and go buy yourself a personal safety box to keep your money in. You don't earn more money but you won't lose it either. Your $1,000 today will still be $1,000 in a year. So the question is why would banks charge a negative interest rate?

Let us take a look at the history of negative interest rates and we will find out. Right now, the only banks that have imposed negative interest rates are the central banks of some countries.

Switzerland

We begin in the 1970's. Switzerland is the first government to charge a negative interest rate. It did so between 1972 and 1978. Why? This country's central bank imposed a negative interest rate to help stabilize the economy and to prevent its currency from rising too much from foreign investors buying its currency. A rising currency is not a good thing. What this means is that the Swiss currency was losing purchasing power as compared to other currencies. As of August 2016, 1 US dollar is worth 0.97 Swiss francs. Now, if the Swiss currency rose, it might mean that 1 US dollar is now worth 2 Swiss francs. Think about what this means. If you had Swiss currency and you wanted to buy a shirt costing $10 US dollars, instead of paying 9.68 Swiss francs, you now have to pay 20 Swiss francs because the currency rose.

When currencies rise, it means that the economy of the country is not doing too well. So, in order to help spur the economy, the central bank of Switzerland started using negative interest rates in hopes of encouraging its commercial bank account holders to lend its money out to people instead of keeping it in the central bank reserves. When a central bank has a negative interest rate, it means that commercial banks have to pay a fee whenever they deposit money into the central bank's reserves. Banks can avoid this if they give out loans to people or invest its own money into the economy.

Sweden and Denmark

For similar reasons, the central bank of Sweden in 2009 and Denmark in 2010 also started charging negative interest rates. Those countries wanted to help their own economies and they hoped that with a negative interest rate at the central bank, commercial banks would be willing to lend to more people, thus strengthening the economy.

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