What negative interest rates mean for you?

Short answer: nothing.

Janet Yellen, Chairman of the Federal Reserve said the Fed will not rule out negative interest rates.

Let’s first explain what happens normally when interest rates are positive. You know that when you borrow money from the bank, you pay back the debt you borrowed and interest. That interest payment is a result of a positive interest rate.

With this logic, one would think that when the interest rate is negative, when you borrow money, you will actually be paid an interest payment rather than paying it. But that’s not the case unless something else happens. But i can’t talk about the something else until I explain what does happen with a negative interest rate.

The Fed lends money to banks at a negative interest rate. Now the bank has a lot more money to lend and so they do. Why? Because they could earn a lot more money by lending rather than simply sitting on it. But the banks lend it at a positive interest rate. The difference between the bank received by borrowing money from the Fed and lending money to borrowers is their profit. That means that if you qualify for a loan, you will likely see a slightly lower interest rate but it will not be negative. This announce means little to most people, then.

In this sense, there is no difference between positive and negative interest rates.

In another sense, they are encouraging borrowers to effectively lend money to other borrowers for an easy return on the borrowed funds. As a matter of fact, because of the stringent lending standards, those who can afford to not borrow will borrow and create their own portfolio of loans. This is essentially expanding the shadow banking industry, rather than decreasing it, which was what the fed tried to do a couple of years ago.

This about face is a result of very low inflation rates in April, which indicates reduction of the economy might be eminent. April’s annualized inflation rate was 0.8%, which is almost non-existent.

The Fed only has two tools: interest rates and money supply. If they increase money supply, they will devalue the currency and make it cheaper for economies using other currencies to purchase US products and services. If they decrease interest rates, they will increase spending because it won’t be as enticing to save money when interest rates are so low.

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