Negative Interest Rates are on the Horizon

Federal Reserve Ready to Test Negative Interest

There are already some countries trying the negative rate such as Switzerland, Sweden, Denmark and Japan. The thought is that negative interest just may force some institutions and businesses that are holding stockpiles of cash in the bank to start spending and hiring in order to get the money into circulation rather than face a penalty for holding on to it. However, there are severe risks to the plan as the Fed considers the likely results, and it is considering what may happen if they undertake that type of manipulation.

As interest rates turn negative around the world, the Federal Reserve is asking banks to consider the possibility of the same happening in the U.S.

In its annual stress test for 2016, the Fed said it will assess the resilience of big banks to a number of possible situations, including one where the rate on the three-month U.S. Treasury bill stays below zero for a prolonged period.

“The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities,” the central bank said in announcing the stress tests last week.

In that particular simulation, the unemployment rate doubles to 10 percent, the same level it reached in the aftermath of the last financial crisis.

But in the stress test, banks would have to handle three-month bill rates entering negative territory in the second quarter of 2016, and then falling to negative 0.5 percent and holding there through the first quarter of 2019.

Fed officials have made clear that they are a long way from contemplating a reduction in rates below zero in their benchmark overnight policy rate. Some, though, have suggested they’d be more open to such a move than in the past should the economy deteriorate significantly.

U.S. policy makers decided against pushing rates below zero during the financial crisis partly because of concern it could lead to dangerous dislocations in the money markets.

The Bank of Japan became the latest monetary authority push rates into negative territory last week in an effort to spur lagging growth and increase too-low inflation.

“It doesn’t signal anything” about future monetary policy, said Perli, a partner at Cornerstone Macro LLC in Washington.

Nevertheless, it is “another sign that the Fed would not be entirely adverse” to reducing its target rate below zero should economic conditions warrant, he said.

New York Fed President William Dudley said last month that policy makers were “not thinking at all seriously of moving to negative interest rates.

“But I suppose if the economy were to unexpectedly weaken dramatically, and we decided that we needed to use a full array of monetary policy tools to provide stimulus, it’s something that we would contemplate as a potential action,” he said on Jan. 15.

As seen in the Bank of Japan scenario, there are those who feel that inflation is actually too low, though you would be hard pressed to hear that concern from the public. But governments, in particular, are anxious to have a moderate rate of inflation because the actual cost on repayment of government debt decreases since money used to repay that debt has become “cheaper.”

Unfortunately, super low interest rates have not spurred the economy, and this new scheme may cause serious disruption.

Unfortunately, it is the public that suffers and is subject to the whims and manipulations of the central bank and politicians who have more control than we know.

Stay tuned, there are those that say we are headed for another economic bubble bursting, this time from the financial markets, and we may experience a new recession in 2016 similar or worse to the one we had in 2009.


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