Following the late-2000s recession, the Federal Reserve consistently held interest rates near record lows, despite an improving U.S. economy. While it seems the markets were undergoing an increasing rate cycle in 2016-2017, it appears to have been short-lived. In the last year, the Fed cut rates for the first time in nearly ten years and Trump wants them to drop even lower.
In 2019, Trump said via Twitter that the Fed “should get our interest rates down to ZERO, or less.” He reiterated this stance in January, urging the Fed to “make our interest competitive” with other nations. European government bonds are increasingly seeing negative interest rates expand.
This change would allow the U.S. federal government to refinance its $23.2 trillion debt for less, but is it actually a good idea?
Here’s what dropping interest rates to zero or less could mean for you, the average American.
What Happens When Rates Drop to Zero?
According to Paul Ashworth of Capital Economics, it would likely take a recession to drop interest rates to zero, in which case we would see noticeable side effects.
Of course, dropping the rates to zero doesn’t mean borrowers wouldn’t have to pay interest on their loans — lenders still have to make money. However, interest rates would likely be extremely low for many borrowers. Though, people tend to be more hesitant to borrow during a recession and credit tends to be less available.
On the other hand, interest rates on savings accounts, for example, would be minuscule. As such, those who depend on returns from their savings accounts would suffer. Just as we have seen since the 2008 Great Recession, savers continue to search for yield.
Lastly, as banks would be turning slimmer profits, they would likely start raising fees to make up for the lost profits. Negative rates would likely give way to higher fees, as financial services companies will look to navigate the changing environment.
The Impact of Negative Rates
With positive interest rates, banks are able to store cash with the Fed and earn modest returns. If interest rates were to drop below zero, the opposite would happen.
Instead of earning interest, banks would have to begin paying interest to store money with the Fed. As a result, banks would likely pass on these costs to the customers by charging for deposits.
This doesn’t necessarily mean the average person would take on these costs. Banks would likely only charge companies and individuals who deposit millions of dollars in order to protect the average person from negative rates.
The idea behind negative rates is that they encourage economic growth by driving banks to lend more money to avoid negative rates and to encourage individuals and companies to spend more of their money.
Fed Plans to Avoid Negative Rates, For Now
The Federal Reserve recently held its January meeting in which members unanimously agreed to maintain the nation’s benchmark interest rate. The Federal Open Market Committee announced it will hold rates in the range of 1.5% to 1.75%.
While other central banks, such as the European Central Bank and the Bank of Japan, have used negative interest rates in an attempt to spur economic growth, the Fed remains hesitant to follow suit.
Many feel that negative rates wouldn’t encourage growth as Trump expects it would. Chris Battifarano, Chief Investment Officer of FineMark National Bank & Trust, pointed to Japan’s economic slump as evidence, stating, “not only does it not work, it’s damaging to banks’ traditional spread-lending mode.”
Article By: Connor Beam