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Are Negative Interest Rates A Real Risk for Savers?

There has been a lot of talk lately about negative interest rates. This year was suppose to be the year when rates were going back to a more normal level. However, the global economic turmoil and the stock market volatility have started to change expectations.

Even though the Fed hasn’t changed plans, it appears likely that their "gradual" rate hikes this year will be more gradual. If the economy starts to tank, we’ll then have to worry about the Fed undoing its last rate hike. In addition, there’s the possibility the Fed may try something that’s being done by a few other central banks: cut rates below zero.

The latest central bank to set negative rates is Japan. At the end of January, the Bank of Japan cut the rate on excess reserves to negative 0.1%. This means that financial institutions will have to pay the Bank of Japan for the privilege of parking reserves that exceed those required by regulators. The Bank of Japan joins several European central banks in setting a negative rate. These include the European Central Bank (ECB) and central banks in Denmark, Switzerland and Sweden.

With this news of the Bank of Japan and with Fed Chair Janet Yellen telling Congressman at last week’s hearings that the Fed is "taking a look" at negative interest rates, the possibility of negative rates hitting the U.S. seems to be real. It should be noted that a lot of things need to happen for us to see negative rates, and that would not happen quickly. First, the economy would need to nosedive. If the U.S. economy heads back into recession, the Fed would first consider undoing its December rate hike. Only then would it even consider negative rates, and that’s only if there’s agreement at the Fed to add this to their "tool box."

If the U.S. economy takes a very bad turn for the worse and the Fed thinks it needs to do more than just go back to its zero interest rate policy (ZIRP) and quantitative easing (QE), it’s possible that the Fed could try negative interest rates. The experiences of Europe and Japan could ease the concerns at the Fed. Hopefully, the U.S. economy won’t take a turn for the worse, and hopefully, the Fed will decide negative rates aren’t worth the risks. I don’t see any chance that we’ll see negative rates in the next year, but there is some possibility that it could happen years down the road.

What would we see if the Fed decides to set interest rates negative? We can learn a little about what to expect based on what happened in Europe. First, individuals in Europe are not being charged negative interest on their bank deposits.

Negative rates would first hurt the banks.

Negative rates would first hurt the banks. Based on what we’ve seen in Europe, it would be unlikely for banks to pass along negative rates to their deposit customers. That’s at least in the early stages of the negative interest rate experiment. However, since negative rates would be hurting the banks, the banks would be forced to be less saver friendly. That means deposit rates closer to zero and more bank fees. Banks may add requirements for opening savings accounts and CDs. Checking requirements and other relationship requirements may become more prevalent.

If the Fed goes down the road of negative interest rates and it thinks that it’s helping the economy, savers could be in trouble. In that scenario, the Fed may be willing to keep cutting rates deeper into negative territory. Banks may be more likely to charge negative interest rates on personal deposit accounts. People will probably keep more cash at home to avoid being hit by the negative interest rates. People may try to prepay as many of their bills they can. The utilities and companies would likely put in place new policies to limit people from prepaying too early.

How would the IRS treat negative interest rates on deposits? I haven’t seen IRS disclose a policy on negative interest rates, but the Danish government has been looking into this issue. It concluded that interest expenses (caused by negative interest) would be tax-deductible for bank depositors and interest income would be taxable for borrowers.

The one certainty of negative interest rates is that savers will be punished even more than what we’ve seen with zero rates. But it’s way too early to worry about negative interest rates. Even if the U.S. economy goes into a recession, it’s far from certain that the Fed will go down that road of negative interest rates.

Previous Comments
  |     |   Comment #1
"How would the IRS treat negative interest rates on deposits? I haven’t seen IRS disclose a policy on negative interest rates, but the Danish government has been looking into this issue. It concluded that interest expenses (caused by negative interest) would be tax-deductible for bank depositors and interest income would be taxable for borrowers."  BUT ..... negative interest rates on IRA accounts would not be tax deductible.  IRA accounts in banks seem to me to be the biggest possible loser on negative rates.
  |     |   Comment #2
As lucid a description and as sensible a prediction as I've yet seen.  Thanks, Ken!
  |     |   Comment #3
Love the penny-pooping piggy bank!
  |     |   Comment #4
What a wonderful explanation of this complex subject! 
  |     |   Comment #5
If rates became negative enough to effect savers they probably have a far nastier suprise like not being able to withdraw cash or deposit it at face value; the Eurozone will hopefully be a warning, though it's likely that Yellen and Draghi would make a joint announcement after it is already in effect
  |     |   Comment #7
Many money market mutual funds are preventing negative yields on their funds by waiving management fees.  If they stop this practice, then the funds will also offer negative interest rates. If the Fed decides to go this path, I expect the mutual fund companies to stop waiving the management fees.
  |     |   Comment #9
As much as I appreciate this first-class description, it's the solutions they keep coming up with that are most troubling:
First came zero interest rates, then quantitative easing, and now negative interest rates — one futile attempt begetting another. [...]    Negative interest rates set stage for next crisis
  |     |   Comment #10
The price of gold has sure been assuming interest rates are at best staying very low or even going negative. Gold has been the best performing asset this year, and a key factor in that is the perception that interest rates are going to be very low for a very long time.
  |     |   Comment #14
Gold is hedge against inflation, it is a sure loser against deflation.
  |     |   Comment #11
The value of your savings can increase with negative interest rates.  If prices decline by 10% due to deflation, but interest rates are negative 5%, the value of your savings (what it can buy) has actually increased.  
  |     |   Comment #12
Your point is well taken.  Only problem is that, at least up until now, the Fed has been viscerally opposed to deflation.  
  |     |   Comment #37
Because deflation breaks normal economic activity. If I can get item X cheaper by waiting Y amount of time, there is going to be a certain segment of the economy who will wait. This is generally bad since stores/manufacturers end up not getting paid and shut down.
  |     |   Comment #16
Are you kidding. Just wait until tax revenues fall in the slightest. Your "earning value" won't be improved a bit.  
  |     |   Comment #13
The solution to all this negativity is obvious to those of us with a bit of mileage on the clock:  a change for the better in leadership at the very top.  In 1979 we faced "malaise".  By 1981 the fix was in place.  And later in that decade we entered into an interval of wonderful growth.  It can happen again, depending on how things unfold this coming November.  There is nothing wrong with America that cannot be put right by leaders willing to make tough choices.  
  |     |   Comment #18
Unfortunately, those tough choices are what most of the U.S. citizens along with all the illegals won't stand for!
  |     |   Comment #39
That certainly depends on what your definition of better is, doesn't it?
  |     |   Comment #43
Agree, but what choices do we have? The Republicans are a joke, and so are Hillary and Bernie.

we need a strong leader who can make a difference and deal with our F-uped Congress. Who might that be?
  |     |   Comment #17
Re IRS consideration, I  expect it already  would be deductible on Schedule A, which provides for deducting your costs for for investing and protecting your money, or on Schedule D  for Capital Gains and Losses. I think it less likely to be considered a capital loss, but that would be a shame since not all bank depositors will qualify or come out ahead by itemizing on Schedule A. 

Of course, this will give a  much smaller  benefit  to  people in lower tax brackets than richer people in higher tax brackets  -- so the rich will stay richer evan as the poor  get much poorer! 

But Anonymous  #1 is correct  that no existing writeoff is available for those who lose in an IRA.
  |     |   Comment #19
You're probably supporting some moron "one-policy" candidate for president that demands that no banks make you provide SS# of beneficiaries.
  |     |   Comment #23
If you owe the IRS back taxes in a negative rate environment and they apply a negative rate for each year you do not pay them.  It appears to me the more time you delay paying them then the less you will owe!
  |     |   Comment #24
Haha #23!  Love this comment!  
  |     |   Comment #38
That doesn't quite work. For one, there are fixed penalties for this kind of thing as well.
  |     |   Comment #26
Math, do the math! You lose 100 pennies to NIRP. You take it as a deduction (one that does not exist) and reduce your taxable income by 100 pennies. You pay 28% tax or 28 pennies. How many pennies did Johnny lose? Answer: Johnny lost 72 pennies. And this is OK because you get a deduction. Oh my.  
  |     |   Comment #27
Remember, a 100 penny reduction in taxes in the 28% tax bracket saves you...28 cents in taxes. 100-28 = 72 cents. My original wording was a bit confusing.
  |     |   Comment #20
Negative rates are not the concern.......Confiscation is the true worry.......And if you don't think that can happen then research Cyprus. It WILL happen here. Matter of time.
  |     |   Comment #30
There would be blood #20.
  |     |   Comment #34
There may be blood, but there won't be any cash value for cash! 

Other proposals being suggested  are for eliminating higher denominational bills, $50 & $100, to make it extremely difficult to deal in large amounts of cash.  Just like our government had done years ago with $500 & $1000 bills.
  |     |   Comment #40
Question: If you handed a cashier a $1000 bill at a grocery shop, what do you expect said person to do considering that giving you change for that might clear out the register?
Bills of that denomination make every day transactions difficult. Sure, it's easier if you're a drug de... I mean, "unorthodox buyer" paying for new cars with cash. But who buys $1000 or even $500 of groceries at one time?
  |     |   Comment #44
Difficult for every day shopping purchases, yes.  But not for the drug trade or under the table purchases discounted for cash transactions.  And then there are legal transactions to be made with large amounts of cash.  Not everyone needs or wants their sales or purchases tracked electronically.  Some people like their privacy and want to maintain the anonymous .
  |     |   Comment #21
That means that hiding money under the mattress or in the old coffee can will provide a higher rate of return.
  |     |   Comment #22
If it's paper currency you're talking about, that coffee can deal works only until they devalue and re-issue the currency . . . you know . . . the famous "old dollars"/"new dollars" ruse.  And then after a while you no longer can convert and the "old dollars" resting peacefully in your coffee can become worthless.
  |     |   Comment #41
Nope. Safes cost money.
  |     |   Comment #42
And where do you put the (original, large $) receipts for home improvements?  All on a memory disk in safe deposit box and originals are....?  Isn't the safe an "improvement" for cost purposes or tax purposes?
  |     |   Comment #25
Many of the comments indicate a complete lack of economics, much less monetary policy. Your CD rates have been deliberately mauled in favor of higher risk. The result of these policies has been a GREATER CONCENTRATION OF WEALTH in the hands of your masters. They won, you lost and your comment is about coffee cans. I wonder if the disparity is gene based or just the inevitable communion between avarice and fiat money.    
  |     |   Comment #48
Kemo Sabe, who is that masked man?
  |     |   Comment #28
From my perspective, a "negative interest rate" is any rate on a 5-yr CD below the prevailing rate of inflation. In my ladder, when rungs roll, my personal "litmus test" is the CPI. With a tight ladder (and assiduous use of Ken's blog), one should be able to beat* (or at least meet) the CPI. It's not all doom and gloom out there, folks.

*I.e., obtain a "real return", in the jargon.
  |     |   Comment #29
When did "you" see a CD interest rate greater than inflation?   Never! 
  |     |   Comment #31
Right, #29....and particularly after taking income taxes into account.
  |     |   Comment #32
Even before
  |     |   Comment #35
I guess you're only a tweeny or teen ager at the most if you never saw CD interest rates higher greater than the inflation rate.
  |     |   Comment #45
#28, respectfully...
When you get your first nursing home bill doom and gloom will be close at hand. Negative interest rates are an admission of FAILURE on the part of central banks to mastermind economies. Money has value and when the premium is negative a very serious problem exists. The ENTIRE system is based on trust and when that trust falters, as in the case of NIRP, the consequences are often tragic. Then again, few care about macroeconomics, in spite of its importance in everyday life.
  |     |   Comment #36
very timely and helpful
  |     |   Comment #46
Folks, NIRP is simple. The FED wants banks to lend money whether they want to or not. NIRP is punishment for not lending. Stupid lending, encouraged by the government, nearly brought the house down. The FED responded with 4T of bond purchases while rates fell to near zero. Cash for clunkers and non-existent shovel-ready jobs came from Congress and the White House. None of it did what they promised...and they knew it wouldn't. It was a game to buttress criminal bank executives who engineered most of the mess. The bankers WON and you LOST. No one went to jail, there was no rejuvenation of the American infrastructure and the monied powers that be got RICHER than you can possibly imagine. NIRP is just a late chapter in a tired text that will ultimately, one day, implode. China is going down a debt hole unseen in human history that will affect each and every one of us. Welcome to global economics.
  |     |   Comment #47
Normalizing the interest rates is one of the ways to save the middle class.
  |     |   Comment #49
There is no such thing as normal interest rates. That's more FED jargon to confuse the masses. 
  |     |   Comment #50
Not any more, there is no such thing as normal interest rates.  Not with the Fed's constant manipulating the rates by fudging the rate of inflation and printing "fiat" currency.  Normal interest rates is what is missing from all the confusing Fed jargon.
  |     |   Comment #51
The FED failed and the NIRP trial balloon is living proof they will continue with their madness. We have all become mad. I spoke recently with someone who, after years of $10/hr jobs is now making $28,000/yr. The individual has $5K IRS debt and $25K credit card debt. The person has no assets beyond a 1K used car. Age 65, below average health and they mentioned they hope to pay off the CC debt (11%) with $500/mo payments so they can "someday" buy a house because renting is not a good deal. When I mentioned the debt would require 68 months of payments to retire, they had no viable credit and therefore no posssibility of receiving a loan they protested and mentioned their last home loan of $99K which subsequently ended in foreclosure. I asked the year. They said 2008. I laughed.      
  |     |   Comment #52
The worry I have is negative rates on IRAs. Say you have 200,000 in a mutual fund IRA, will you have to take money out of the IRA to pay a fee for the negative rate. If you have a MRD of three percent will you have to take out an extra percent tax and then pay tax on the MRD and the extra funds? Would the government make this a progressive tax and increase the tax on funds on a scale?
  |     |   Comment #54
A few months ago, the experts agreed: mortgage loan interest rates could not stay so low – they were going to rise

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