While discussions about interest rates can be awfully boring, monetary policy affects our lives profoundly. Central banks around the world are experimenting with monetary policy that’s never been used in the history of mankind, and that’s leaving many observers nervous about the future of the global economy.
Before the Great Recession, the formula for stimulating the economy used to be so easy. During a recession, or a contraction of the economy, the Federal Reserve would lower interest rates to boost growth. Lower interest rates would increase money available for borrowing, and the economy could recover. Like a get out of jail free card, policy makers always had wiggle room to get the economy going again.
Today, with interests rates barely above zero, there are serious questions about what the “Fed” can do to combat the next economic downturn. Right now, there are fears that there’s another global recession around the corner, and that’s leading many countries to experiment with negative interest rates.
Here in the United States, the “Fed” sets the federal funds rate, which is the amount banks charge one another for borrowing money. This is the rate that influences all other interest rates across the entire economy. In December of 2008, the “Fed” lowered interest rates all the way down to zero for the first time ever. It stayed there until December of last year, and was raised to just above zero.
Meanwhile, in the Eurozone and Japan, central bankers are seeing prices drop and their economies slow down. Because they were already at zero, they’ve introduced a negative interest rate to combat sluggish growth. Wrap your head around this: an interest rate below zero means that rather than receiving money on deposits, institutions and people who put money in the bank are charged for storing their money.
While most banks in countries with negative interest rates have resisted charging customers, it’s expected that people will eventually have to pay for the privilege of depositing their money. So far, contrary to expectations, people have not stuffed their cash in their mattresses in nations with a negative interest rate policy.
Given that some of the largest central banks on Earth are now using negative interest rates to prevent another recession, are sub-zero interest rates coming to America? Wall Street is terrified of another recession, and that’s showing up in the downward swinging stock market. Is the “Fed” going to resort to this unconventional monetary tool?
Right now, America is looking economically solid compared to the rest of the world, so negative interest rates aren’t yet on the table. But what will policymakers do once we hit a wall and there’s another recession? The short answer is no one knows, and negative interest rates may be the “Fed’s” only hope. As former Treasury Secretary Larry Summers has pointed out, “how policy can delay and ultimately contain the next recession…demands urgent attention.”
One thing is certain; if negative interest rates do come to America, the political fallout will be enormous. It will be extremely difficult to explain to the all-American saver why they’re being charged to keep money at the bank. The controversy that would erupt over this potential policy means that the “Fed” should think twice before lowering interest rates below zero.