economic theory

A Negative Interest Rate?

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In the past few days, I have come across this question multiple times: “What would happen if there was a negative interest rate?”

First, let me define a positive, then a negative, interest rate.  Banks want us to give them our money so that they can lend it to others.  The bank pays us to give it our money then charges a premium to others to borrow that same money.  A negative interest rate would result in us paying the bank while we give it our money.  This is not entirely unfeasible; in fact, with the recent rise in bank fees, this may be the case for some smaller accounts. 

In a piece in Slate Online Magazine by Matthew Yglesias, which I commented on in my last post, Yglesias describes a negative interest rate as “in effect a tax on holding cash in the bank”.  He continues with the logic that if this were the case, we would all store money in shoeboxes.  That is, unless there was no physical money only “electronic” currency that we were forced to pay this “tax” on.  Then, he argues we could stimulate demand by “raising this tax” or equivalently making the interest rate more negative.

But even in the simple model economy I described in my last post (The Economic Overlapping Generations Model), a negative interest rate results in saving.  Specifically, by the need to store the value of current production.  The Value of Money is based on our need to store value not in the interest rate that we receive from the bank.