The big chill in interest rates

Many central banks are pushing their rates below zero to stimulate their economies. But is that a good idea?

Sub-zero in Canada usually refers to freezing weather. Right now, in financial circles, it refers to central banks pushing interest rates below 0% -- a “cold front” that is sending a chill down the spines of many observers, reports the Global Post.

In 2009, Sweden’s Riksbank was the first central bank in the world to lower its interest rates below zero. On February 11, it pushed deeper into the cold zone, setting its rate at -0.5%, down from -0.35%.

Many other central banks are heading the same way, notably the European Central Bank, the Bank of Japan, the Danish National Bank and the Swiss National Bank. Even the US Federal Reserve (which has started to raise rates), has not ruled out the possibility of a radical policy reversal.

In the banking world, commercial banks stash away money with their central bank in order to meet minimum reserve requirements. Ever since the financial crisis, many banks have been overcome with risk aversion to the point where they have been hoarding much more than the minimum reserve requirement.

Normally, the central bank pays a small percentage on those holdings. When rates turn negative, it means the central bank is charging banks to hold that money for them. The message is clear, and it is a desperate one: get the money out by giving out loans, with the hope that credit activity will stimulate economic growth.

Some economists think negative rates could prove dangerous. For example, if banks decided to pass on the cost to their customers, it could cause bank runs. It they absorbed it, it could weaken their profitability and destabilize the whole financial system. Also, extremely cheap credit could cause asset bubbles to form. These bubbles might then burst, as was the case with the last financial crisis.