How does negative rate policy work?
Mains Paper 3: Economy
Prelims level: Negative rate policy
Mains level: Significance of the Negative rate policy
- Negative rate policy is becoming a more attractive option for some
countries’ central banks.
- This policy would counter unwelcome rises in the currencies of these
Why have some central banks adopted negative rates?
- To battle the global financial crisis triggered by the collapse of
Lehman Brothers in 2008, many central banks cut interest rates near zero.
- A decade later, interest rates remain low in most countries due to
subdued economic growth.
- With little room to cut rates further, some central banks have resorted
to unconventional policy measures, including a negative rate policy.
- The euro area, Switzerland, Denmark, Sweden and Japan have allowed rates
to fall slightly below zero.
How does it work?
- Under a negative rate policy, financial institutions are required to pay
interest for parking excess reserves with the central bank.
- That way, central banks penalise financial institutions for holding on
to cash in hope of prompting them to boost lending.
- The European Central Bank (ECB) introduced negative rates in June 2014,
lowering its deposit rate to -0.1% to stimulate the economy.
- Given rising economic risks, markets expect the ECB to cut the deposit
rate, now at -0.4%, in September.
- The Bank of Japan (BOJ) adopted negative rates in January 2016, mostly
to fend off an unwelcome yen spike from hurting an export-reliant economy.
- It charges 0.1% interest on a portion of excess reserves financial
institutions park with the BOJ.
What are the pros, cons?
- Aside from lowering borrowing costs, negative rates weaken a country’s
currency rate by making it a less attractive investment than that of other
- A weaker currency gives a country’s export a competitive advantage and
boosts inflation by pushing up import costs.
- But negative rates put downward pressure on the entire yield curve and
narrow the margin financial institutions earn from lending.
- If prolonged ultra-low rates hurt the financial institutions’ health too
much, they could hold off on lending and damage the economy.
- There are also limits to how deep central banks can push rates into
negative territory – depositors can avoid being charged negative rates on
their bank deposits by choosing to hold physical cash instead.
What are central banks doing to mitigate the side-effects?
- The BOJ adopts a tiered system under which it charges 0.1% interest only
to a small portion of excess reserves financial institutions deposit with
the central bank.
- It applies a zero or +0.1% interest rate to the rest of the reserves.
- The ECB is expected to take “mitigating measures”, such as a partial
exemption from the charge in the form of tiered deposits rates, if it were
to deepen negative rates from the current -0.4%.
- But designing such a scheme won’t be easy in a bloc where cash is
distributed unevenly among countries.
- It could even backfire by pushing rates up in certain countries, rather
Q.1) Which of the following provisions regarding national emergency was
not enacted by the 44th Constitutional Amendment Act?
(a) Substituted the word 'armed rebelllion' for 'internal disturbance'.
(b) Enabled the President to limit the operation of the emergency to a specified
part of India.
(c) Proclamation by the President can be made only on a written recommendation
from the cabinet.
(d) Periodic approval for further continuation by both the Houses of the
Parliament by special majority.
Q.1) Define negative rate policy. How does it work? What are the pros, cons of
negative rate policy?