It’s not unusual for interest rates to be negative in the sense of being lower than the rate of inflation. If the Federal Reserve pushes interest rates below inflation to stimulate growth, it becomes cheaper to borrow and buy something now than to wait to make the purchase. If you wait, inflation could make prices go up by more than what you owe on the loan. You can also think of it as inflation reducing the effective amount you owe.
What is rarer is for interest rates to go negative on a nominal basis—i.e., even before accounting for inflation. The theory was always that if you tried to impose a negative nominal rate, people would just take their money from the bank and store cash in a private vault or under a mattress to escape the penalty of paying interest on their own money. When the Federal Reserve slashed the federal funds rate in 2008 to combat the worst financial crisis since the Great Depression, it stopped cutting at zero to 0.25 percent, which it assumed to be the absolute floor, the zero lower bound. It turned to buying bonds (“quantitative easing”) to lower long-term rates and give the economy more juice.
Now comes the interesting part. There are signs of an innovation war over negative interest rates. There’s a surge of creativity around ways to drive interest rates deeper into negative territory, possibly by abolishing cash or making it depreciable. And there’s a countersurge around how to prevent rates from going more deeply negative, by making cash even more central and useful than it is now. As this new world takes shape, cash becomes pivotal.
Fascinating. It's understandable why banks would want to move to a cashless society, but it might not be a bad idea. The mindset shift required might take a generation or two to overcome, cultural inertia being such a powerful force. What usually wipes the slate clean, as morbid as it may be, is simply the dying off of the previous generation.
Heist movies would be a lot less fun minus Brinks armored trucks and giant vaults filled with cash. I'm fine with a cashless society, but I may be more trusting of government than the average citizen. Those less trusting in government might be more inclined to have a virtual currency like Bitcoin replace cash, but virtual currencies come with technological opacity for the average person that carries its own trust issues.
Like chemotherapy, negative interest rates are a harsh medicine. It’s disorienting when people are paid to borrow and charged to save. “Over time, market disequilibria are dangerous,” G+ Economics Chief Economist Lena Komileva wrote to clients on April 21. Which side of the debate you fall on probably comes down to how much you trust government. On one side, there’s an argument to be made that cash has become what John Maynard Keynes once called gold: a barbarous relic. It thwarts monetary policy and makes life easy for criminals and tax evaders: Seventy-eight percent of the value of American currency is in $100 bills. On the other side, if you’re afraid that central banks are in a war against savers, or that the government will try to control your financial affairs, cash is your best defense. Taking it away “is a prescription for revolution,” Cecchetti says. The longer rates break on through to the other side, the more pressing these questions become.