Negative interest on excess reserves is an instrument of unconventional monetary policy applied by central banks to encourage lending by making it costly for commercial banks to hold their

excess reserves Excess reserves are bank reserves held by a bank in excess of a reserve requirement for it set by a central bank. In the United States, bank reserves for a commercial bank are represented by its cash holdings and any credit balance in an account ...

at central banks so they will lend more readily to the private sector. Such a policy is usually a response to very slow economic growth,

deflation In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but sudden deflatio ...

, and

deleveraging At the micro-economic level, deleveraging refers to the reduction of the leverage ratio, or the percentage of debt in the balance sheet of a single economic entity, such as a household or a firm. It is the opposite of leveraging, which is the pr ...

. During economic downturns, central banks often lower interest rates to stimulate growth. Until late in the 20th century, it was thought that rates could not go below zero because banks would hold onto cash instead of paying a fee to deposit it. It turns out this was not quite right. Central banks in Europe and in Japan have demonstrated rates can go negative, and several have pushed them in that direction for the same reason they lowered them to zero in the first place—to provide stimulus and, where inflation is below target, to raise the inflation rate. The notion is that negative rates will provide even more incentive for commercial banks to make loans. What might have looked like a potential lending project, by a bank, not worth funding even in a low-interest-rate environment might now look attractive if the alternative is being charged to store money at the central bank or holding a large amount of cash.

Examples

Europe

The

European Central Bank The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's most important centr ...

and central banks of other European countries, such as Sweden, Switzerland, and Denmark, have paid negative interest on excess reserves—in effect taxing banks for exceeding their

reserve requirement Reserve requirements are central bank regulations that set the minimum amount that a commercial bank must hold in liquid assets. This minimum amount, commonly referred to as the commercial bank's reserve, is generally determined by the centra ...

s—as an expansionary monetary policy measure. Negative rates in Europe have been controversial. Ambrose Evans-Pritchard of the London Telegraph has described them as a "calamitous misadventure." Economists for the European Central Bank argue that across the euro area, loans from banks to corporations have become less expensive since negative rates were adopted.

Japan

In January 2016, the Bank of Japan followed European central banks and lowered its interest rates below zero, after several years of keeping them at the lower end of the positive range. The existing balances will keep on yielding a rate of 0.1 percent; the reserves that banks are required to keep at the BOJ will have a rate of zero percent, and a rate of minus 0.1 percent will be applied to any other reserves.

United States

The staff of the

U.S. Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

prepared a memo for the

Federal Open Market Committee The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System (the Fed), is charged under United States law with overseeing the nation's open market operations (e.g., the Fed's buying and selling of United States Treas ...

in August 2010 evaluating the possibility of lowering the interest rate that the Fed paid on bank reserves to zero or below. The staff was lukewarm on the idea, and it was never adopted in the U.S. Former chairman of the Federal Reserve Ben Bernanke has argued that "negative rates appear to have both modest benefits and manageable costs" and "modestly negative" interest rates should be an option for the Fed to consider if it ever again confronts a very weak economy at a time when short-term interest rates already have been cut to zero.

References

External links

Why has the ECB introduced a negative interest rate?
(European Central Bank, June, 2014)
"The ECB's Negative Interest Rate: The Fed May Be Forced To Follow Its Lead"
(former Dallas Federal Reserve President Bob McTeer, ''Forbes'', June 5, 2014)
"Will the European Central Bank’s negative interest rate be an economic positive?"
(Simone Pathe, PBS ''Newshour'', June 9, 2014) *