Negative Interest Rates: Explained

[Music] this is Sweden a very advanced Scandinavian country that is home to some of the wealthiest citizens on the planet it is also the birthplace of negative interest rates in July of 2009 the bank of Sweden lowered its overnight deposit rate to negative 0.25 effectively charging the retail banks of the country to pay it to look after their money at the turn of the millennia negative interest rates were somewhat of an economic fantasy in the same way that faster than light travel is a fantasy for theoretical physicists economists had speculated about what negative interest rates would mean but nobody ever really expected them to exist in the real world today negative interest rates dominate the market for sovereign bonds and are the staple of many central banks but like how does this make sense who in their right mind would pay someone to take their money well to understand this properly you must first understand what interest rates and central banks are truly intended to do in the first place monetary policy is the controlling of interest rates by central banks central banks operate in almost every major economy in the world and control the cash supply for their respective economies when an economy is going really really well people will have lots of confidence in the good things that are happening and are going to be happening in the future and be happy to go out and spend building bigger houses getting new cars and boats and jewelry oftentimes on credit this is pretty great for an economy that is reliant on consumer spending it will mean more jobs for people and boost overall material quality of life when this spending is happening on credit cards or car loans or through home loans though it can effectively overheat an economy people are effectively borrowing from their future earnings to pay for stuff now if the economy continues to grow and wages continue to rise in line with the interest rates on these loans this is fine if I borrow $50,000 for a new car at a 5% interest rate but I get a 7 percent pay rise every year it's actually not such a bad thing for me and fent tastic for the economy overall one thing it does cause though is inflation if everybody has access to cheap credit through low rate car loans readily available credit cards or even competitive home loans it means that the average person has more immediate buying power if home loans were not a thing for example it is extremely unlikely that homes would cost as much as they do today the average family household income of $80,000 would struggle to save two hundred and fifty thousand dollars they could easily borrow that amount and go to an auction where they could compete with other individuals who could also service of two hundred and fifty thousand dollar loan and lo and behold the price of the house will be two hundred and fifty thousand dollars this increased price of goods is called inflation and isn't limited to just real estate it is the most obvious example where people's true purchasing power is inflated by their ability to borrow but it also impacts far more mundane transactions people wouldn't spend as much shopping if it wasn't for credit cards when credit cards got kind of a bad reputation has been devices of overconsumption retailers started working with brands like after paid because they know the average consumer will spend more if they can buy now and hand over actual cash later on down the road all this purchasing on credit doesn't really actually increase people's buying power though it just makes the same things cost more which is inflation a central bank's primary purpose is to control inflation despite what most people think they are not there to control the economy as a whole normally inflation and a strong economy go hand in hand but economic prosperity is more or less just a happy little side effect to a central bank when they see people borrowing like crazy to buy boats and clothes and homes and cars they just see inflation now they want a certain level of inflation normally around 2% to 3% as a measure to stop people just sitting on piles of money but they don't want inflation to go above 4% if an economic boom happens like the scenario mentioned before they will raise interest rates what this means is that commercial banks like JP Morgan or Citibank or Bank of America borrow money from a central bank and then at a markup and then to regular customers if the central bank raises their rate then these banks will raise theirs now particularly for people that have variable rate home loans this will mean that they have much less money left over at the end of the month to spend they will also be paying more interest on their credit cards and car loans and won't have the same borrowing power as they had before what this means is that people won't be able to buy as much and so retailers will be forced to be more competitive on price to attract a smaller group of customers and this is deflation now the opposite is also true central bank's really don't like deflation because again it will cause people to just stuff cash under their mattress and never use it as a pretty terrible form of investing so if people aren't spending enough to raise the general price level of goods and services in an economy the central bank will lower interest rates this suddenly means that the average borrower can afford to pay off larger home loans or get a fancier car on a loan while meanwhile being less tempted to keep cash sitting in a bank because suddenly the interest return that they are getting is pretty terrible this causes inflation and generally stimulates the economy now post global financial crisis and eurozone crisis many countries have had a lull in confidence people have become more savvy about saving and banks are becoming more restrictive with lending this has caused instances in many countries where inflation and growth has been well below the targeted level so the respective banks of these countries lower their rates and then lower them again and again and again until a little suddenly we have a rate of 0% aren't too much more than that right well yeah actually I guess they could go negative a huge point that must be made here was that there was a very very big Asterix next to the negative interest rates from the central banks of the first countries that adopted this in Sweden for example the overnight cash rate effectively the interest rate central banks charged commercial banks was still positive at 0.75% it was the deposit rate eating the interest rate that central bank gave other banks for keeping their cash with it that was negative this isn't exactly too crazy the average high interest savings account may have an interest rate of 2% whereas the average home loan may have an interest rate three and a half percent of course these figures were completely random and based off generally the most secure household lending banks do but there is always a margin between borrowing and savings rate the amount a bank will pay out as interest for savings will always be lower than what they charge you in interest for borrowing and the same is true for central bank's so in this early case banks were not yet been paid to borrow they were just having to pay to deposit which again isn't that crazy negative interest rates don't really exist on savings accounts for regular people per se but many bank accounts come with no interest at all and a monthly account keeping fee this effectively works out to be you paying the bank to keep your money so the early days of negative interest rates weren't true negative interest rates but they do exist today many sovereign bonds have negative interest rates and the official lending rate for many of the world's central banks is now properly negative they are not just charging people to save money they are paying people to borrow so the question remains why would people loan money at a negative interest rate this sounds like one of those rare times where stuffing your money into a mattress would literally be a better investment well the thing is average everyday people like you or I and not making these types of investments the people buying negative yield bonds are major financial institutions and governments these type of big boys have way too much money to reasonably keep as cash so they have two options buy extremely secure assets like government bonds or stick their money in their local central bank well suddenly if the central bank of their home countries are turning a negative 0.5 percent interest rate the negative 0.2 percent interest rates from sovereign bonds actually looks like a really good alternative and you may ask why don't I just keep the money in a bank account like normal businesses or people do and well the thing is they are the bank these negative rates are also subject to a really weird type of speculation the largest market for negative yield bonds is the Japanese sovereign bond market which currently returns a negative 0.2 percent return now in terms of investing this is what the boys in the business called not great but things to consider the Japanese yen which these bonds are denoted in is super stable and is speculated to be continuing to grow in value compared to the US dollar and most other world currencies which actually neutralizes the impact of negative interest rates which means suddenly these type of bonds are just a better way of keeping cash around than the negative interest rates in their central banks the speculation gets even weirder though for anybody who has done finance you will know about a concept called projected future value of investments for those of you who have never done finance I'm so sorry you're gonna have to enjoy this what future value does is assess if an investment is worthwhile making based on what it could be worth in the future and what you could otherwise invest in now as fun as the mass of all of this is I will spare you from it what you need to know is that if you can lock in an investment yielding negative 0.2% today and suddenly that same type of bond drops to yield negative 1% tomorrow you will profit it sounds like the dumbest thing that people will actually pay you a premium in order to buy a bond that means that they will have to pay slightly less money to the people that originally borrowed the money there have been fears that negative interest rates leveraged on regular savers will cause a run on the banks this is the worst nightmare of most economists where everybody suddenly goes to draw the money from their bank all at once and the bank does not have enough cash to pay everybody out so far though this has not really been the case in the rare instances that people are charged negative interest rates they are extremely minimal and relatively inconsequential compared to the regular bank fees that we've discussed earlier it is likely going to be just another price that people are willing to pay for the convenience of modern banking if it ever becomes a widespread reality negative interest rates are very odd but if you take away nothing else from this video just remember that there will never be a time where you are paid to borrow money as unfortunate as that may be the weird world of negative interest rates is pretty much the domain of large financial institutions and governments but I mean who knows I could be proven wrong 15 years ago if you ask the world's top economists they would probably laugh at you for the theory of negative interest rates all this weird somewhat desperate move caused issues down the track well yeah it very likely could but we just don't know yet negative interest rate through an abstract concept 15 years ago the moment they are an accepted reality and all we can do is speculate about their future but I hope for now at least you can understand them hi guys I hope you enjoyed the ladies video if you did please consider liking and subscribing I have left a link to our discord channel in the video description below I will be hanging out on here answering questions for an hour after this video goes live so if you want to come on and have a chat that's fantastic otherwise I will be doing my very best to answer all serious comments in the comment section below thanks guys bye

Channel: Economics Explained

Views: 499,202

Keywords: negative interest rates explained, the economics of negative interest rates, how do interest rates work, how do interest rates affect the economy, how do interest rates go below zero, how do interest rates go below 0, how do interest rates go negative, how do negative interest rates occur, how do interest rates impact the economy, interest rates negative, negative interest rates, interest rates explained, interest rates economics explained, economics explained

Id: sLWulVrQvsY

Length: 12min 11sec (731 seconds)

Published: Thu Nov 07 2019