How Negative Interest Rates Ruin Our Economies

There is a chance we will see them in the US soon

Mario Draghi, president of the European Central Bank (ECB), addresses the media following a meeting with the ECB’s council in Frankfurt, on Sept. 6. The European Central Bank has applied the concept of negative interest rates to money banks hold at the Central Bank. Johannes Eisele/AFP/Getty Images

As the U.S.-China trade war deepens, it creates ripple effects throughout the world. Growth rates are falling in China and other economies from Asia to Europe. In response, central banks are cutting interest rates to stimulate economic activity and growth.

It’s More Than the Trade War

Though the trade war isn’t the only cause of slowing growth in China, it is a major factor. Costly business regulations and social programs in places such as in Japan and the European Union are also a drag on economic activity and investment. What’s more, even though modern economies run on debt, too much debt in the system hinders growth and demand. But central banks are betting cheaper borrowing costs will stimulate investment in the economy.

However, lowering interest rates to counter sluggish demand isn’t always effective. Falling interest rates can have their own psychological impact on the business cycle and undermine business confidence instead of improving it. Adding more debt-fueled liquidity to stimulate demand in the economy then leads to diminishing returns on said debt and eventually default.

A Race to the Bottom

Of course, dramatically cutting interest rates also tend to devalue a currency. That’s a real temptation because it makes a country’s goods and services cheaper on the world market relative to other currencies. When one country does this, however, others often do as well to gain the same advantage. It becomes a race to see who can devalue their currency the fastest. At the same time, those nations with devalued currencies import fewer goods, since those goods have become relatively more expensive. A vicious circle of devaluation and economic contraction can occur.