European Central Bank

In a landmark monetary policy move, the European Central Bank (ECB) has announced negative interest rates. The ECB will charge an interest rate of -0.1% to banks wishing to store euros within central bank vaults. Domestically, the intention is to prod banks into lending money to businesses as opposed to buying government bonds. Internationally, the intention is to cause depreciation of the Euro relative to other currencies to increase the competitiveness of European exporters. It is unlikely that individual users in the 18 countries under the ECBs control will see negative interest rates on their savings accounts. It is more likely that banks will swallow the cost (-0.1%) and continue to offer zero-interest bearing accounts as has increasingly become the norm around the world now. However, Europeans will still have an effective negative interest rate on their bank holdings due to the leveraging of bank fees combined with zero-interest bearing accounts. The term savings account has turned into somewhat of an oxymoron.

CCN

Negative Interest Rates

C entral banks around the world have tread the long sliding path to negative interest rates for the last few decades. In May, ECB President Mario Draghi brought the Euro area interest rate down to 0.5%, and many suspected that negative interest rates were coming. In the history of fiat currencies, only the Nationalbanken of Denmark had previously instituted negative interest rates back in 2012. It is important to note that Denmarks economy didnt move drastically in either direction as a result, contrary to the jeers of opposing economists from Keynesian and Austrian camps. Notably, the American central bank and the English central bank have both long avoided making such a drastic move. Even the Keynesians fear the reality of near zero interest rates, something that is referred to as a liquidity trap. Whether you believe in the power of liquidity preference or time preference. the ECBs move tells us something about the current state of the world economy.

Real Interest Rates

The Fisher equation allows economists to estimate the real interest rate when the nominal interest rate and the inflation rates are known.

Where    r  is the real interest rate,  i  is the nominal interest rate, and  π  is the inflation rate.

Luckily (or unluckily depending on who you ask), large central banks such as the ECB have very clear inflation targets. Currently, the ECBs inflation target is 1.1%. Even prior to the most recent ECB announcement, Europe had a negative real interest rate. The real interest rate is the real  rate that you will get when lending your money because it accounts for government created inflation in the monetary supply. Theyll tell you that inflation in the monetary supply is supposed to counteract inflation in the price level. The United States has an inflation target of 2% since 2012.

Results Of ECB Announcement