How negative interest rates work? (Part 1)

Central banks of the developed countries have engineered and implemented one of the most radical economic experiments in the history of the world. After several years of Zero Interest Rates Policy which was implemented as a reaction to the global financial crisis of 2007/2008 (and as a reaction to stock exchange and real estate crisis of 1990 in case of Japan), two years ago the central planners of Japan and several European countries decided to ease the monetary policy even further, by introducing Nominal Negative Interest Rates Policy. Nominal negative interest rates have never been tried in practice by any central bank in history. Theoretical considerations for negative interest rates (or “tax on money” or “Gesell”s tax”) were studied by some niche economists (eg. Silvio Gesell) but has never received any considerable attention from any of the major school of economics – Austrian, Monetarist or Keynesian.

Central bankers have decided to run an economic experiment on a living organism (world economy) without any theoretical background or even a possibility to consult history for similar experiments. Central bankers of the world are setting up a financial fusion reactor in downtown Tokyo, Brussels and New York without being properly trained in the theoretical and practical aspects of financial fusion energy. This can’t end up well.


We are going to analyse possible implications of negative interest policy by following Henry Hazlitt’s definition of prudent economic analysis: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”. We will look into short term and long term consequences of negative interest rates to consumers, small and medium enterprises, corporations, financial institutions and governments.


Publicly listed corporations are required by regulations to report their balance sheet each quarter. Individuals also have a balance sheet (even though most of us don’t produce official financial statements). There are three major categories on the balance sheet. Assets, liabilities and equity. Physical cash, cash deposited on a bank account, a car or real estate are examples of individual’s assets. Credit card debt, car loans, and mortgage are individual’s liabilities. If we subtract liabilities from assets we arrive at individual’s equity.

When analyzing balance sheet of a company, professional investors look for companies which have a strong balance sheet. They seek enterprises with lots of productive assets and few liabilities. The same rule apply to analysis of balance sheet of an individual. Someone who has a lot of cash, owns a car and a big house is a wealthy person. If he also has no credit card, car loan and mortgage we can claim this person has a strong balance sheet. On the side of the financial spectrum we have a person who has very little cash, he has huge a student loan and a pile of credit card debt. He has a poor balance sheet because he has no assets and lots of liabilities.

Society is a set of individuals. If the total assets of all individuals in the society are higher than the total liabilities of these individuals, then we can say that this society is more wealthy than the set of individuals (society) with the opposite ratio.



First of all, it is important to understand negative interest rates will not be transmitted to consumers immediately. Banks have to analyse the potential consequences of charging depositors a negative rate (does it make from business and risk perspective?). Even if commercial banks are charged by the central bank (and so in consequence they are losing money on their deposits in the central bank) they may or may not charge the customers. Secondly, banks’ IT systems are ones of the most complex and bureaucratic out there. Most of these systems have been implemented several years ago. At that time no one ever thought about this crazy idea that the interest rates can be negative.  Reprogramming banking IT systems to facilitate negative interest rates will take several months (best case scenario).

Regardless of the difficulties, some of the banks in Switzerland (Alternative Bank Schweiz)Netherlands (Achmea NV), and Denmark (Realkredit Danmark) have already started lending and/or accepting deposits with negative interest rates.

If the whole banking industry decides to go full power with negative interest rates we may expect the following.

In the world of negative interest rates, the borrowers (these individuals which increase their liabilities) are REWARDED for taking liabilities on their balance sheet. Negative interest rates mean that a person who takes a loan will receive annual payments. The more negative interest on the loan, the more money he will receive. Who is paying for this madness? Individuals who deposit money on the bank account (individuals which increase their assets by postponing consumption) pay the interest. In the world of negative interest, these individuals WILL HAVE TO pay the bank to keep their money in the bank account.

Assuming 2% interest rates on deposits, if you deposit $10.000 to a bank account, after ten years you will end up with $8.171.


How far into a negative territory can interest rates go? Assuming no government interventions they shouldn’t drop further than the cost of a self storage units. If markets offer to rent a self storage unit (where $10.000 of physical cash would be deposited for the annual fee of $300), customers would prefer to spend $300 per annum for the storage than paying 4% ($400) negative interest rates on the time deposit. Cost of self storage can strongly influence lower bound of negative interest rates.

It seems that central banks and governments are aware of this limitation (which could lead to a run on banks and a rapid withdrawal of liquidity from the banking system). In order to protect the system from this risk they have proposed two financial repression tools – 1) limit on maximum cash transactions between individuals and companies, 2) complete ban of physical cash.


Financial repression from the government to force individuals to keep their assets in a bank is spreading across the Western world. Several governments banned cash transactions above government set threshold. The maximum cash transaction allowed in France is 1000 EUR (has been reduced from 3000 EUR), in Spain (2500 EUR), Italy (1000 EUR), Portugal (1000 EUR), Greece (1000 EUR). Polish government from Christian-Socialist party has proposed decreasing the maximum allowed cash limit from 15.000 EUR to 3750 EUR (15k PLN).

The long-term goal of the governments is to ban cash altogether. European Central Bank has proposed to eliminate 500 EUR notes from circulation. Former Secretary Treasury, well known democratic socialist Larry Summers proposed to ban $100 bill in the US. Official, politically correct reason for this proposal is “fighting money laundering, drug trafficking and tax evasion”. The fact that the ECB has proposed this legislation in the same time when they introduced negative interest rates policy is of course a complete coincidence. In the last hundred years criminals never used cash for illegal activities. These naughty criminals, they started doing cash settlements just in time when the ECB has introduced negative interest rates policy. Sure, we believe you.

As always with government intervention, there will be unintended (but easy to predict) consequences of this policy. If general population decides to keep cash in mattress (to avoid being charged negative interest rates by banks) criminals will know about it. Expect the number of burglaries and robberies to increase.

The biggest issue with negative interest rates is related to assets/liabilities structure of the society. The only way the society prosper and become wealthier is by increasing assets of each individual. Forcing society to acquire more liabilities (negative interest rates promote credit build-up) can only make everyone poorer. Negative Interest Rates Policy is skewing the balance sheet of each individual to the liability side.

Policy of low interest rates started in 2000 and ended in second half of 2004 has been one of the major reasons for the financial crisis of 2007.



Low interest rates environment, together with the encouragement from the federal government (via public-private establishments Freddie Mac and Fannie Mae) to increase lending to low income households resulted in a bubble in real estate market which busted in 2007 and has resulted in the global financial crisis and recession (grey area on the chart).


Policy of low interest rates between 2000 and 2005 has resulted in massive real estate bubble. Central bankers has learned nothing from the lesson and have lowered the interest even further and for longer than in the previous credit cycle. We should therefore expect the next crisis to be much more severe and painful for individuals.

If you liked this post and would like  get a notification about part 2 (which will treat about impact of negative interest rates on corporations and financial institutions) like our facebook page.


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