The latest Central Bank tool used to combat slow economic growth are negative interest rates (NIRP). But what are negative interest rates and how does it work? For now, it's a policy being used outside of the US, in places like the Euro Zone and Japan. The Euro Zone recently went more negative while Japan went negative for the first time in its history. If the US Central Bank elects to use this policy what will it look like and how will it affect mortgage rates?
Who Uses NIRP?
The ECB, Denmark, Sweden, Switzerland and Japan are employing NIRP. The Euro Zone started using NIRP before deciding to use Quantitive Easing or asset purchases back in June 2014. Employing NIRP is a sign of economic desperation to combat deflation and slowing or falling growth. The ECB was the largest central bank to use NIRP. In January of 2016 Japan started using NIRP for the first time in its history.
Why Use NIRP?
When conventional measures to stimulate growth are not effective central banks turn to less conventional means to promote economic growth. Other non-conventional measures include asset purchases and zero-interest rate policies (ZIRP). In theory these programs are meant to stimulate borrowing and promote spending by businesses and households.
Why They Might Not be Effective
Lowering interest rates was meant to stimulate borrowing and encourage consumption by businesses and consumers. Unfortunately, businesses have not borrowed to the extent that central banks had hoped and capex has flatlined or fallen as businesses have not found the demand needed to justify investment. In regards to consumers, lower rates meant to encourage refinancing by homeowners was stifled by a lack of equity allowing for bank lending. Once homeowners successfully refinanced their homes, the savings were either put in the bank or went to pay down other debt items therefore failing to invigorate the moribund economy.
Are They Coming to the US?
NIRP is an option for the US but as of now Central Bank president Janet Yellen has not elected to employ them. If the US can hit its inflation target of 2% the Central Bank will likely not use NIRP, however, if the economy stalls and deflation becomes a threat, Janet Yellen may be forced to use NIRP. It would mean lower borrowing costs for businesses and households. Consumers will have another chance to refinance their mortgages to an even lower payment. 1% on the long bond will become a reality and mortgage rates could hit 2% on the 30-year mortgage.
Are Banks Going to Charge Consumers to Save?
As of now, this is not how NIRP is being employed. Central Banks are charging large financial institutions to park funds with them. The Euro Zone recently moved the rate it charges institutions to park money with them to -0.30%. This is meant to dissuade lenders from parking money at the Bank and to encourage them to lend it out to borrowers. Consumers are not being charged to keep money in a savings account nor are they being paid to borrow.
The Danger of Market Distortions
Analysts are critical that NIRP and other non-conventional monetary policies may have adverse effects on financial markets and may lead to further difficulties than those they are meant to solve. Obvious casualties of NIRP are lending institutions and financial institutions that rely on spreads between interest rates to make profits. Banks borrow at low rates and lend at higher rates to make profit. As interest rates come down those spreads get squished and profits fall. When rates go negative these institutions incur costs that may pass on to consumers to maintain profit margins. If not, they become less profitable. Part of a healthy economy is a healthy financial system made up of healthy banks. If they become compromised and find less incentive to lend, credit markets could suffer and markets could be facing another 2008 style calamity. This is the danger of market distortions.
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