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Could Negative US Interest Rates Rescue the World’s Economy?

Not long ago, the idea of a central bank moving its interest rate into the negative territory seemed absurd. Yet here we are, in 2020, facing the biggest economic crisis in our lifetimes, and negative interest rates are already here.

When the economy performs, central banks raise the interest rate level to fight potential rising inflation. Commercial banks are discouraged from lending to people and businesses, as the monetary policy becomes contractionary. The opposite happens in a crisis – the central banks lower the interest rate so as to motivate commercial banks to borrow. As such, the monetary policy becomes expansionary.

Traditionally iIn trading financial markets, it is often enough to trade the interest rate differential between different currencies, to be successful. Thus, the idea of negative interest rates challenges both investors and monetary policymakers.

The JPY Example

The Bank of Japan was the first one to introduce negative interest rates on excess reserves. In other words, commercial banks in Japan with excess reserves, faced two options – either lend the money to the real economy or park it to the Bank of Japan, paying interest instead. The idea, obviously, was to stimulate commercial banks not to part with the money.

For a currency, this has a dilutive effect, because suddenly the money supply in the economy increases. The JPY appreciated for over six months after the Bank of Japan initially introduced negative rates. The USDJPY pair, the most relevant one, fell from 120 to 100 within that period.

Will the Fed Go Negative?

All major central banks have their interest rates at the lower boundary. Moreover, they all engage in some sort of additional easing.

In some economies, like the Eurozone or Switzerland, negative interest rates have existed for years now. Any additional easing, as it was the case, came via different programs meant to stimulate the economy.

Many economists argue that the Fed should go negative too. The stronger dollar tends to do more harm than good due to its status as the world’s reserve currency. Negative rates on the dollar should weaken it and offer some relief, especially to emerging markets.

However if history tells us anything, the JPY example is good enough to question such logic. In the end, it is a game of trust in a currency’s ability to provide a store of value, negative interest rates, or not.

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