In late January, Japan's central bank, the Bank of Japan, surprised markets by announcing an unusual policy. Rather than paying banks a positive rate of return on excess reserves, it would begin charging 0.1 percent. The central bank hopes that this negative interest rate will encourage banks to increase lending and thereby spur greater economic activity in a country that has suffered from weak growth for almost two decades.
While highly unorthodox, negative interest rates are not unheard of. Switzerland adopted negative rates on foreign deposits in the 1970s to counter outside pressure on its currency. And the Bank of Japan is actually the fifth central bank to dip its toes into negative territory in more recent times.
Negative rate policy has even been discussed in the United States, despite the fact that the Fed raised rates in December and has said it is likely to raise rates further. In February testimony, Federal Reserve Chair Janet Yellen said that negative rates weren't "off the table," though she has since told legislators in June that negative rates were not something the Fed was "actively looking at."Doing Away With Cash:
For the casual observer, the idea of banks charging savers for the privilege of keeping their money and paying borrowers to take on more credit seems backward. In fact, economists long assumed that it would be impossible to make nominal rates significantly negative because depositors would simply withdraw their funds into cash, an asset that always pays a nominal interest rate of zero. Given this challenge, how and why have monetary policymakers in Europe and Japan pushed rates negative?
Goodfriend also notes that while holders of digital currency may lose money in times of negative rates, they could actually earn a positive return when rates are above zero, something paper money currently lacks. "If we expect that interest rates are going to be positive most of the time, then for most of the imaginable future, people are going to benefit from earning interest on currency."