By Dan Bobkoff
Samantha Lee / Business Insider
If you’re a bank, the idea sounds crazy. Why pay someone to hold your cash?
In 1983, when Frederic Mishkin started writing “The Economics of Money, Banking and Financial Markets,” his seminal textbook on macroeconomics, he never thought he’d devote much space to the idea of negative interest rates.
“A million years no,” Mishkin told Business Insider.
Negative rates were seen as a bizarre thought exercise by academic economists, not something any of us would see in the real world.
It was “absolutely unthinkable when I started writing this book,” Mishkin, a former Federal Reserve governor and professor at Columbia Business School, said.
In fact, it took just about 30 years. And as Mishkin finishes the 12th edition of his textbook, he’s devoting a whole lot of space to negative interest rates.
“There’s something very shocking about this,” Mishkin said. “I have to talk about how negative rates are something that can be very prevalent.”
At a basic level, a negative interest rate occurs when a lender pays someone to borrow its money.
The policy has evolved from radical idea to mainstream policy of postrecession governments in Europe and Asia. And in the US, Federal Reserve Board Chair Janet Yellen has said the US will not rule out using them if it needs to.
This is because the Great Recession has rewritten the rules of what can happen — and how central banks can respond — during financial crises. Negative rates could affect just about everyone, notably businesses, banks, homeowners, and anyone with a savings account.
The old way
The US Federal Reserve in Washington, DC.
Centrals banks, like the Federal Reserve in the US or the Bank of England in the UK, control a country’s supply of money and set the interest rates that apply when a bank lends to another bank, usually to meet mandates for how much each bank has to keep in reserve.
And for much of the past century, our economic system has worked something like this:
You earn money through your job. You deposit some of that money in your bank. The bank takes a portion and lends it out to customers and stores some of the rest at the Federal Reserve. If it has more at the Fed than is required by regulation, it lends the extra to other banks, which might not have enough in reserve. That’s called interbanking lending, and the interest rate we’re talking about when we talk about the Fed changing rates applies to that lending between banks overnight. This is actually the most important rate in the country. All other major interest rates are based on it, at least indirectly.
Changing this rate is a kind of lever that the Federal Reserve can pull to make things happen in the economy. If it wants to spur banks to lend, which should boost the economy, it lowers the rate. That eventually makes mortgages and car loans more affordable for consumers. If it wants to slow a raging economy, it raises interest rates.
And for most of our modern financial history it was inflation — the increase in prices — that kept central bankers up at night. As Kenneth Rogoff, an economics professor at Harvard, recently told Business Insider, when he was studying economics in the late 1970s, “Everyone said we’d never grow fast again. Inflation was double digits.
“If you had told me we’d be in some future where central banks were struggling to get inflation up from zero or 1% and they wanted i