Negative Interest Rates, something from Alice in Wonderland?

With the Reserve Bank cutting the Official Cash Rate (OCR) to 1.0% we are moving closer to the weird world of negative interest rates.

Negative interest rates refer to a scenario in which cash deposits incur a charge for storage at a bank, rather than receiving interest income. Instead of receiving money on deposits in the form of interest, depositors must pay regularly to keep their money with the bank, that is you invest $100 and get $95 back! In addition, you need to take into account inflation; if deposit interest rates fall to 2.0% and with an inflation rate of 2.0% you are very close to being negative in real terms. Negative interest does currently exist in some parts of Europe.

The theory behind all this is to stimulate economic activity. Banks will be encouraged to increase lending, making it easier to borrow money which will then be spent on goods and services and increase economic activity. However, negative interest rates can also lead to “asset bubbles”, people looking for higher returns start to buy other assets such as property, shares, gold, or anything with a return greater than zero and thereby push the price of these assets up to unrealistically high levels.

As Alice said “Curiouser and curiouser!”