How negative interest rates could have a positive economic impact

Normally when you putmoney in a savings account with a bank, you earn money on that deposit.

If you were to deposit $100 at a 0.5 per cent interest rate, for example, you would have $100.50 at the end of the year.

A negative interest rate would work the other way if you were to deposit $100 with a negative 0.5 per cent interest rate, you end up with$99.50 in your account in a year's time.

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The concept of paying to have someone look after your savings may be strange, but that's what many are pondering after news this week that the Bank of Canada could theoretically move itsbenchmark interest rate below zero as a new weapon in its policy-making toolkit.

But even if negative rates do come to Canada, nobodywill be paying you to take out a mortgage anytime soon.That's because the banks are likely to swallow thatcost without passing it on in any direct way.

Cost of saving

In practice, if a bank decides to park its money with the Bank of Canada, a negative interest rate would meanbanks are essentially paying for the privilege to do so.

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With a hypothetical rate mentioned Tuesday by central bank governor Stephen Poloz of minus 0.5 per cent, down from the current rate of 0.5 per cent, that would mean banks depositing their money with the central bank would lose 50 cents for every $100 they deposited.

But why would anyone accept a negative return when they could just hold onto their cash and earn zero return?

"The average person would probably keep their cash under their mattress," said BMO chief economist Doug Porter.

Poloz on negative rates

9 years ago

Duration 25:28

Governor of the Bank of Canada discusses new policy tools at the bank's disposal

But if banks were being "punished for saving,"as Porter puts it, and losing value on whatthey keep on deposit with the central bank, they would essentially be encouraged to stop hoarding their cash.

In turn, this could lead to banks lending more toconsumers and businesses, saidPatti Croft, an independent economic analyst and former chief economist of RBC Global Asset Management.

"When faced with the choice of lending money and getting a rate of return on their loans, or eat fees to keep their money in the Bank of Canada, most banks would choose the former," saidCroft.

She said negative interest rates wouldn'taffect consumers looking to save their money, meaning they wouldn't have to pay the bank to storetheir cash, because interest rates offered by banks to savers "never go below zero."

Pros and cons

Theuptick in borrowing and lending caused by negative interest ratescould provide a much-needed boost to Canada's economy.

A potential risk is thatbanks may turn to investing in riskier assets to secure a return,potentially inflating asset values anddriving new asset bubbles.

Negative interest rates "free people to spend instead of save," saidPorter, adding that he believes there is "not enough saving" as it is.

Croft saidbanks could lend more in such a scenario, but she points out that banks could also try to avoidpotentially risky loans as negative interest fees squeeze their profit margins.

Though there are potential positives and negatives, Porter saidthat with Canada's interest ratealready low at 0.5 per cent, a move into the negative would yield "not much impact."

Croft adds that although the implementation of negative interest rates often denote an "economic crisis" and are seen as a "sign of desperation,"she agrees withPolozthat Canada is not facing that kind of difficulty.