# Negative Interest Rates Explained: Reasons and Effects

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*— Investopedia / Laura Porter*

## What Is a Negative Interest Rate?

Negative interest rates, an unconventional monetary policy tool, are used primarily during significant economic downturns. In these situations, central banks may opt to credit borrowers interest, encouraging spending and investment rather than cash hoarding. This method aims to stimulate economic growth and counteract deflationary pressures when traditional interest rate cuts reach their limits.  

### Key Takeaways

*   Negative interest rates occur when borrowers are credited interest instead of paying it, a policy frequently implemented during severe economic downturns to stimulate economic activity.  
    
*   Central banks adopt negative interest rate policies (NIRP) to encourage banks to lend money instead of hoarding cash, thereby promoting spending and investment.  
    
*   Countries like Japan, Switzerland, and the eurozone have used negative interest rates as a tool to counteract deflation and stimulate economic growth.  
    
*   Though negative interest rates aim to boost the economy, their effectiveness in achieving these goals remains uncertain, as commercial banks are hesitant to pass negative rates onto consumers.  
    
*   Negative interest rates are intended to prevent deflationary spirals by discouraging savings and encouraging borrowing, thus promoting economic circulation.

## How Negative Interest Rates Work

An [interest rate](https://www.investopedia.com/terms/i/interestrate.asp) is effectively the cost of borrowing. This means that lenders charge borrowers interest when they take on any type of [debt](https://www.investopedia.com/terms/d/debt.asp), such as a loan or mortgage. Although it may seem strange, there are instances where lenders may end up paying borrowers when they take out a loan. This is called a negative interest rate environment.

Central banks and regulators usually set negative rates. They do so during deflationary periods when consumers hold too much money instead of spending as they wait for a turnaround in the economy. Consumers may expect their money to be worth more tomorrow than today during these periods. When this happens, the economy can experience a sharp decline in [demand](https://www.investopedia.com/terms/d/demand.asp), causing prices to plummet even lower.

When strong signs of [deflation](https://www.investopedia.com/terms/d/deflation.asp) are present, simply cutting the central bank's interest rate to zero may not be sufficient enough to stimulate growth in both [credit](https://www.investopedia.com/terms/c/credit.asp) and lending. This means that a central bank must loosen its monetary policy and turn to negative interest rates.

Therefore, a [negative interest rate environment](https://www.investopedia.com/terms/n/negative-interest-rate-environment.asp) occurs when the nominal interest rate drops below 0% for a specific economic zone. This effectively means that banks and other financial firms have to pay to keep their excess reserves stored at the central bank, rather than receiving positive interest income.  

> **Important**
>
> In a negative interest rate environment, an entire economic zone can be impacted. As such, storing cash incurs a fee rather than earning interest, which means that consumers and banks have to pay interest in order to deposit money into an account.

## Important Factors in Negative Interest Rate Policies

While [real interest rates](https://www.investopedia.com/terms/r/realinterestrate.asp) can be effectively negative if inflation exceeds the nominal interest rate, the nominal interest rate is, theoretically, bounded by zero. This means that [negative interest](https://www.investopedia.com/articles/investing/070915/how-negative-interest-rates-work.asp) rates are often the result of a desperate and critical effort to boost economic growth through financial means.

The zero-bound refers to the lowest level that interest rates can fall to. Some forms of logic dictate that zero would be the lowest level. However, there are instances where negative rates have been implemented during normal times. For instance, the [target interest rate](https://www.investopedia.com/terms/t/target-rate.asp) in Switzerland was negative until September 2022. [Japan adopted a similar policy](https://www.investopedia.com/articles/markets/080716/why-negative-interest-rates-are-still-not-working-japan.asp) until March 2024.

### Impact of Negative Rates on Commercial Banks

With negative interest rates, commercial banks are charged interest to keep cash with a nation's central bank, rather than receiving interest. This dynamic should theoretically impact consumers and businesses. But in reality, commercial banks are generally reluctant to pass negative rates onto their customers.  

## Economic Impacts of Negative Interest Rate Policies

A [negative interest rate policy](https://www.investopedia.com/terms/n/negative-interest-rate-policy-nirp.asp) (NIRP) is an unusual monetary policy tool. Nominal target interest rates are set with a negative value, which is below the theoretical lower bound of 0%.

When people hoard money rather than spend or invest it, [aggregate demand](https://www.investopedia.com/terms/a/aggregatedemand.asp) collapses. This leads to prices falling even further, a slowdown or halt in real production and output, and an increase in [unemployment](https://www.investopedia.com/terms/u/unemployment.asp).

A loose or expansionary monetary policy is usually employed to deal with such economic [stagnation](https://www.investopedia.com/terms/s/stagnation.asp). However, if deflationary forces are strong enough, simply cutting the central bank's interest rate to zero may not be sufficient to stimulate borrowing and lending.

 It's unclear if an NIRP effectively achieves its goals in the countries that use it. It's also unclear whether or not negative rates have successfully spread beyond excess cash reserves in the banking system to other parts of the economy.

> **Fast Fact**
>
> Individual depositors aren't charged negative interest rates on their bank accounts.

## Real-World Examples of Negative Interest Rates

Central banks in Europe, Scandinavia, and Japan have applied negative interest rates to excess bank reserves. This policy aims to spur growth by encouraging spending and investment, prompting depositors to spend rather than save and incur losses.

## How Can Interest Rates Turn Negative?

Interest rates tell you how valuable money is today compared to the same amount of money in the future. Positive interest rates imply that there is a time value of money, where money today is worth more than money tomorrow. Forces like inflation, economic growth, and investment spending all contribute to this outlook. A negative interest rate, by contrast, implies that your money will be worth more—not less—in the future.

## What Do Negative Interest Rates Mean for People?

Most instances of negative interest rates only apply to bank reserves held by central banks; however, we can ponder the consequences of more widespread negative rates. First, savers would have to pay interest instead of receiving it. By the same token, borrowers would be paid to do so instead of paying their lender. Therefore, it would incentivize many to borrow more and larger sums of money and to forgo saving in favor of consumption or investment. If they did save, they would save their cash in a safe or under the mattress, rather than pay interest to a bank for depositing it.

Note that interest rates in the real world are set by the supply and demand for loans despite central banks setting a target. As a result, the demand for money in use would grow and quickly restore a positive interest rate.

## Where Do Negative Interest Rates Exist?

Some central banks have set a negative interest rate policy (NIRP) in order to stimulate economic growth in the financial sector, or else to protect the value of a local currency against exchange-rate increases due to large inflows of foreign investment. Countries including Japan, Switzerland, Sweden, and even the ECB (eurozone) have adopted NIRPs at various points over the past two decades.

## Why Would Central Banks Adopt NIRPs to Stimulate the Economy?

Monetary policymakers are often afraid of falling into a [deflationary spiral](https://www.investopedia.com/terms/d/deflationary-spiral.asp). In harsh economic times, such as deep economic recessions or depressions, people and businesses tend to hold on to their cash while they wait for the economy to improve.

This behavior, however, can weaken the economy further as a lack of spending causes further job losses, lower profits, and price drops—all of which reinforce people’s fears, giving them even more incentive to hoard. As spending slows even more, prices drop again, creating another incentive for people to wait as prices fall further, and so on. When central banks have already lowered interest rates to zero, the NIRP is a way to incentivize corporate borrowing and investment and discourage hoarding of cash.

## The Bottom Line

Negative interest rates represent an unconventional monetary policy tool where borrowers receive interest payments instead of paying them. Central banks use this approach during severe economic downturns or deflationary periods to stimulate economic activity by promoting borrowing and spending and discouraging cash hoarding. By charging banks on their reserves, central banks incentivize lending and investment. However, the effectiveness and broader impacts of a negative interest rate policy remain uncertain and controversial.

> **Article Sources**
>
> 1.  Swiss Info. "[Switzerland Exits Negative Interest Rate Era](https://www.swissinfo.ch/eng/business/switzerland-exits-negative-interest-rate-era/47920304)."
>     
> 2.  CNN. "[Japan Brings Era of Negative Interest Rates to an End with First Hike in 17 Years](https://www.cnn.com/2024/03/18/business/japan-boj-negative-interest-rate-ended-intl-hnk/index.html)."
>     
> 3.  International Monetary Fund. "[How Can Interest Rates Be Negative?](https://www.imf.org/external/pubs/ft/fandd/2020/03/what-are-negative-interest-rates-basics.htm)"