UK joined Japan and Europe to implement negative interest rates. Why do negative interest rates happen? What is the impact of negative interest rates for a country and her citizens?

Last week, United Kingdom (UK) sold government bonds in negative interest rates for the first time. The £3.8bn auction by the debt management office (DMO) sold three-year government bonds with a yield, which indicates the interest paid, of -0.003%. This means investors have to pay to lend money to fund the government’s response to the Covid-19 outbreak. UK with this move has joined Japan, Switzerland, Denmark, and the Eurozone in implementing negative yields. This move reflects the prospects of a severe global recession and bond-buying by central banks to mitigate its impact.

“We know that we may have to draw on our tool kit at any point and looking very carefully at the experiences of those other central banks that have used negative rates, and a number of them are actually publishing quite interesting assessments at the moment.” Andrew Bailey, the Governor of Bank of England

Why Negative Interest Rates

#1. Stimulate Borrowings

Negative interest rates discourages savings as one would lose money by saving. This also encourages more borrowing and spending to stimulate the economy. Banks are incentivized to lend money to borrowers earning some interest rather than being charged by the central bank to to hold on to money. Overall businesses would then be incentivized to take on more risk. All this helps fight against deflation.

#2. Policy Bazooka

Although an unpopular policy tool and unorthodox monetary move, it has been used since before the global financial crisis. Negative interest rates would not be used in isolation but used together with large-scale asset purchases and using forward guidance to manage rate and inflation expectations.

#3. Fear of Falling Returns

People fearing returns continue to fall would rather have negative interest rates than losing even more. The situation is one where people are are more concerned with the return of capital rather than the return on capital. Saving in an account with a negative interest rate would typically entail paying a very small fee for keeping your money in a bank.