What are negative interest rates?

Negative interest rates represent a policy regime in which the central bank sets its benchmark rate below zero percent. In practice, this means commercial banks are charged a fee for depositing excess reserves at the central bank rather than earning interest. The intent is to incentivize banks to lend money rather than park it, boosting credit creation, spending, and inflation when the economy is stuck at the zero lower bound.

The European Central Bank, Bank of Japan, Swiss National Bank, and Swedish Riksbank all implemented negative rates during the 2010s. The ECB's deposit facility rate reached negative 0.50%, meaning banks were paying 50 basis points per year to hold reserves at the ECB. The Bank of Japan introduced negative rates in January 2016, pushing its deposit rate to negative 0.10%. These experiments lasted for years: the ECB maintained negative rates from 2014 to 2022, and the BoJ did not exit until 2024.

The transmission mechanism is complex and debated. On one hand, negative rates can push down lending rates, weaken the currency (encouraging exports), and force investors into riskier assets. On the other hand, negative rates compress bank net interest margins because banks are reluctant to pass negative rates through to retail depositors, effectively imposing a "reversal rate" below which further rate cuts actually tighten financial conditions by harming bank profitability.

The Federal Reserve has not implemented negative rates, though the zero lower bound was tested during 2008-2015 and again in 2020. Fed officials, including Chair Powell, have consistently expressed skepticism about negative rates for the US, arguing that the costs to money market funds, bank profitability, and market functioning outweigh the marginal stimulus benefits. Instead, the Fed has relied on quantitative easing and forward guidance when the funds rate reaches zero. However, the negative rate experiments in Europe and Japan provide important lessons for what tools are available if the US faces another severe deflationary shock.