Last month, the euro fell hard across the charts when ECB President Mario Draghi brought up the idea of implementing negative rates in order to spur growth.
But what the heck does that mean?
Should Draghi and the rest of the ECB policymakers decide to implement negative rates, they would begin charging banks for keeping their cash parked at the central bank. Think of it as a form of negative reinforcement–banks would be punished when they leave their cash to sleep in the ECB‘s vaults.
The primary purpose of this is to encourage banks to issue more loans and credit to consumers and businesses. That way, there’s more liquidity available in the economy which could consequently lead to a pick-up in growth.
Such a move isn’t exactly new. Denmark imposed negative rates in July 2012. Analysts argue that the move has worked well for the country as it has helped ward off the upward pressure on the Danish krone and allowed the EUR/DKK peg to remain steady.
Those who are in favor of negative rates say that, similar to Denmark, the ECB would also be able to help boost the region’s exports as it would limit the euro’s moves. Another upside to it could be that banks in the core nations would be encouraged to lend to banks in the periphery where credit is low. Heck, it may just trigger interbank lending throughout the region!
But of course, as with anything in life, there’s always another side to every theory.
Skeptics think that negative rates won’t have that much of an effect. Remember that banks have weekly repayments to the ECB for the bank’s Long-Term Refinancing Operation (LTRO). In order to avoid the extra cost of negative rates, banks can simply increase the amount they repay the central bank.
To top it off, there are worries that we could see banks pass on the added cost of negative rates to consumers. The move could then backfire as consumers and businesses would be discouraged to get loans because of higher rates. Yikes!
Most market junkies argue that the ECB won’t implement negative rates anytime soon. They say that we’ll have to see incredibly bad economic data to convince them to pull the trigger on it.
But regardless, do you think it’s a good idea or is the ECB better off resorting to other measures to spur economic growth?