Europe’s Central Bank Is Paying Negative Interest Rates. What Does That Mean?

The European Central Bank tests out the radical idea of interest rates that are less than zero. Will this keep the Eurozone from slipping back into deflation?

Europe’s Central Bank Is Paying Negative Interest Rates. What Does That Mean? 140605_inv_europeneg_draghi_1

Europe’s Central Bank Is Paying Negative Interest Rates. What Does That Mean? 140605_inv_europeneg_draghi_1

At least we’re not Europe.

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While Americans are starting to shift their attention to the next economic war — against inflation, as MONEY’s Pat Regnier notes – European policymakers are still frantically trying to fight the last one against deflation.

Toward that end, the European Central Bank on Thursday took the extraordinary step of going negative — that is, it cut the interest rate that it offers banks for holding excess reserves from 0% to -0.10%. It was part of a broader stimulus plan that also included a cut in another key European benchmark rate from 0.25% to 0.15%.

The extreme measures indicate just how worried European policymakers are about the threat of deflation.

But how do negative interest rates actually work?

Well, banks in the region will now be punished for keeping excess reserves at the ECB rather than deploying that money in the economy.

In the U.S., for instance, our central bank — the Federal Reserve — pays banks 0.25% on excess reserves that they keep on deposit. (In turn, banks pay you interest for parking your money in their CDs and money market accounts). By contrast, European banks who want to deposit their excess reserves will now be dinged 0.10%.

The move is designed to encourage banks to deploy their excess cash by investing it and loaning it out to spur economic growth, rather than just sitting on it.

Maybe encourage isn’t the right word. As David Kotok, chief investment officer at Cumberland Advisors, described it last year: Negative rates “employ only a stick and no carrot. Their use tends to progress from disincentive through penalty to punishment.”

http://time.com/money/2826672/the-europeans-go-negative-what-exactly-are-negative-interest-rates/

Europe’s Central Bank Is Paying Negative Interest Rates. What Does That Mean?

Europe’s Central Bank Is Paying Negative Interest Rates. What Does That Mean?

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