To review: Interest rates are the price of lending and saving money. When interest rates throughout the economy are low, banks charge less for loans and individuals have less incentive to save; when they're high, lenders charge more and individuals save more. This is why central banks tighten interest rates when they're worried about inflation: Discouraging loans and encouraging individuals to sock their money away slows economic activity, which keeps inflation in check. Conversely, cutting interest rates in a recession encourages credit and consumption, which boosts job creation.
If interest rates could go negative — and banks started
charging people for depositing their money — then this logic extends out: Not only would we be encouraging people to save less, we'd be actively penalizing them for saving rather than consuming. But the
general assumption in economics has been that interest rates can't go below zero. Cash already has an implied interest rate of zero, so if banks started charging negative interest rates, people would just stuff paper cash in mattresses.
But in the last year and half, central banks throughout the advanced western world became desperate enough to start
experimenting. In 2014, the European Central Bank (ECB) started charging eurozone banks a -0.2 percent interest rate. Central banks in Denmark and Switzerland set deposit rates at -0.75 percent, and Sweden set it at -1.1 percent. Last Thursday, the decision-makers at the Bank of Japan
surprisedinternational observers by getting in on the act as well: By a 5-to-4 vote, they
decided to impose a -0.1 percent rate under certain circumstances.
Will it work? No one really knows, as the close vote indicates. But to even approximate an answer, we need to work through a few of the specifics of how central banks function.
