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Interest is the cost of borrowing money, and you generally have to pay interest when you take out a loan or carry a credit card balance. Conversely, when you put money into a savings account, the bank usually pays you interest. A nation's central bank—in the U.S., that's the Federal Reserve—can influence the interest rates that banks charge or pay their customers. Central banks may choose to set low or negative interest rates to encourage borrowing that stimulates the economy.
What Are Negative Interest Rates?
Negative interest rates are when interest rates go below 0%. There are two types of interest rates that economists may consider when discussing negative rates:
- Negative nominal interest rates: The nominal interest rate is the interest rate that a nation's central bank charges banks it regulates. Financial institutions may base the interest rates they charge or pay other companies and consumers on the nominal rate.
- Negative real interest rates: Real interest rates are the nominal interest rate minus inflation. Even if the nominal rate is positive, real interest rates could be negative when inflation is higher. For example, if you earn 4% on your savings account but inflation is at 6%, you might be losing 2% of your purchasing power each year.
In the U.S., the federal funds rate is the nominal rate the Fed sets—it determines how much banks pay or earn to lend money to each other on an overnight basis. It has never dropped below zero, and there are questions about whether the Fed even has the right to implement negative interest rates. However, a low nominal rate has still led to negative real interest rates at times.
Other countries and regions have implemented negative interest rates. For example, the European Central Bank and the central banks of Denmark, Japan, Sweden and Switzerland implemented negative interest rates after the 2008 global financial crisis and in response to the COVID-19 pandemic.
When Would Negative Rates Be Implemented?
Negative interest rates may be implemented to spur economic growth that can help a country avoid or end a recession. Decreasing interest rates can do this in several ways:
- Banks may try to increase how much money they lend.
- People and businesses may be more likely to borrow and spend money.
- People and businesses may look for ways to spend or invest their savings.
- The exchange rate could decrease, which can result in increased exports of goods and services to other countries.
Although negative nominal rates have never happened in the U.S., the nominal rate was lowered to a target range of 0% to 0.25% during the Great Recession and the COVID-19 pandemic.
Risks of Negative Interest Rates
Economists debate the effectiveness of negative interest rates, as dropping and keeping rates low could have several negative effects:
- Decreased foreign investment: Although lower exchange rates can help increase exports, they may decrease foreign investments.
- Increased housing prices: Low or negative rates may result in low mortgage rates, which could lead more people to buy homes and increase home prices.
- Disrupted financial markets: Banks use deposits to finance their lending activity. Low or negative interest rates could lead people to withdraw money, which might make it more difficult for others to get a loan.
How Negative Interest Rates Could Impact Consumers
Although negative interest rates can affect how much banks pay to keep their money at the central bank, the negative rates don't necessarily result in negative rates on consumer accounts. Still, the effects might be noticeable in several ways:
- Lower cost of borrowing: The interest rate on various types of loans, including mortgages, auto loans, personal loans and credit cards may drop. Borrowers may be able to refinance or pay off their debts and put the money they were spending on interest into savings, investments or purchases.
- Lower interest rates on savings accounts: Savings accounts may offer low interest rates, which can make saving money less appealing. Consumer accounts generally don't have negative rates, as banks know it's relatively easy for consumers to move their savings elsewhere or keep the money as cash.
- More fees on deposit accounts: Banks might introduce or increase fees on checking and savings accounts to offset the decreased earnings from deposit and lending activity.
- Lower yields on fixed-income investments: Fixed-income investments, such as bonds and treasuries, may offer lower yields. This could be particularly difficult for retirees who generally use these low-risk investments to preserve their savings and generate income for living expenses.
- Rising stock market prices: The lower rates may also prompt investors to sell fixed-rate investments and move their money into stocks, which could lead the stock market to rise.
Your Credit Can Also Affect Your Interest Rate
Although the interest rate you receive when borrowing money can be influenced by the central bank's rate, creditors will also consider your creditworthiness when offering you a loan or credit card. Improving your credit can help you qualify for the best available rates. And you can track your credit report, credit score and the main factors influencing your scores for free with an Experian membership.