IMPACT OF NEGATIVE INTEREST RATES ON INTERNATIONAL FINANCE

. IMPACT OF NEGATIVE INTEREST RATES ON

INTERNATIONAL FINANCE

1. Introduction to Negative Interest Rates

A. Definition and Concept

The Lublin University of Economics Negative nominal interest rates are a non-conventional

monetary policy measure whereby central banks set interest rates below zero. To encourage

spending, this strategy is used when there is deflationary gap or during any deep economic

slowdown. The intended outcome is therefore, to make the banks more aggressive in extending

credit and to encourage people and companies to spend money and create demand to stimulate

economic growth. in a negative interest rate regime, commercial banks are actually charged for

the holding excess reserve at the central bank. This charge is designed to real and encourage the

banks that are holding a lot of reserve from lending and instead encourage them to lend. This is

expected to help chip away the borrowing costs in the economy to help spur more investments

and consumption (Goodfriend, 2016). When the opportunity cost if holding money is more than

the return on the same, the incumbent banks are likely to advance credits to businesses and

consumers thus engorging the real economy. Negative interest rates work on the key concept of

discouraging the accumulation of money and encouraging spending through increasing the

overall demand o (Buiter, 2009). It penalize keeping money idle, while, positive interest rates

make savers lucky and postpone consumption. What this does is to shift the financial objectives

to a place where having cash becomes disadvantageous and hence spending or investing

becomes favorable. Its purpose is thus, to increase of market turnovers, as well as provision of

economic stimuli which will enhance the formation of liquidity. The utilization of negative

interest rates has nonetheless, received numerous criticisms from critics. Several potential

negative consequences has been identified by critics pertaining to the current global economy.

One thing that needs to be considered is whether such a policy is sustainable or may even prove

counterproductive past a certain point. However, the advantages of negative interest rates may

decrease over time since negative interest rates can decrease bank profit and incentives

associated with lending can weaken over time since consumers may reduce their borrowing as

interest rates continue to decrease (Eggertsson et al. , 2019). Also, such As with most monetary

policy measures, there is always the danger of messing up the financial market and developing

asset bubbles. During the period where the interest rates are very low or even negative, investors

might look to gain more profits out of risks hence a situation where the prices of the assets gets a

boost and this leads to rise in market volatility. Another criticism is invariably the possible

decline in the profitability of the banks. Self-fulfilling prophecy On the other hand, negative

interest rates have been seen as pointing a threat to the margins of banks since they are likely to

narrow the difference that is usually realized between the rates at which banks borrow on

deposits and the rates at which it lends out its funds. This may thus, have negative effects on the

policy‟s goals of increasing the availability of credit as it could stifle lending. However, negative

rates sustained can be burdensome because it reduces returns and have problematic effects on

savers, especially the elderly focusing on income from their savings. It may lower overall

consumption if for any reason, households become cautious due to less income from savings. In

addition, it is unclear what exactly negative interest rates mean for the long term, or even the

medium-term. Potential threats of continuning such rates for long time can distort the consumers

and businesses‟ behaviour in quite unexpected manner which can be counterproductive to the

policy in question. Some critics have likewise identified the fact that this approach can therefore,

be considered as suspect and thus, may undermine public confidence in efforts being

championed by the central bank. Negative interest rates pose concerns yet are hence, considered

to encourage expenditure and discourage saving and have emerged as an effective tool to

revitalize the economy. It can thus, offer short-term positive effects in terms of economic

development but it has long-term consequences that include a lack of sustainability, negative

deterioration in the structure of the financial markets, deteriorations in the return on capital for

commercial banks, and a negative effect on savers. On balance, there is nothing wrong with

negative interest rates if central banks make a conscious effort to consider all these factors before

employing this policy.

B. Historical Context

The idea of negative interest rates is new in the context of globalisation and has only been

applied by the Central Banks around the beginning of the 21st century. Among the first to

embark on this unaltered measure, were the European Central Bank (ECB) and the Bank of

Japan (BoJ) since they sought to restore inflation and growth rates which slumped after the

global financial crisis of 2008 (Rogoff, 2017). Bond yields have fallen by over ¾ since 2014,

with the ECB starting to introduce negative interest rates to combat deflation and boost the

Eurozone economy. This policy was an unprecedented deviation from the longstanding monetary

approaches and was thus, perhaps a manifestation of ECB‟s dire need to stimulate employment

in the euro area. For purpose of encouraging lending and investment in the Eurozone, the ECB

sought to impose a fee on the banks for keeping excess reserves with it. He targeted raising the

outlay for business enterprises and consumers so that total demand and consequently price levels

rise. Similarly, in 2016, something similar to the ECB‟s policy, the Bank of Japan introduced the

negative interest rates on deposits with an aim to revive the economy facing deflation risks and

accelerate monetary circulation (Fukui, 2017). The same case applies to the BoJ that embarked

on the implementation of negative interest rates for similar reasons of finding new options of

policy after the regular policies such as fixing interest rates on sub-zero levels had been

employed. Such central banks have opted for negative interest rates which are applied to help

reverse severe rates of near-stagnation in the economy. As conventional tools to accomplish

monetary policy goals failed in the environment after the collapse of the credit boom, central

banks began to search for new combinations of instruments. Deflation coupled with negative

interest rates, appeared as the last hope, aimed at halting low inflation and people‟s inactivity. It

is such a background that reveals the general dynamics of the modern central banking in the

contemporary context. Central banks have learnt to adjust to events of high uncertainty by

applying unknown approaches to economic macro management. The persistence of negative

interest rates demonstrates that there is a shift towards an operation that is not typical in ordinary

circumstances but rather in period of crises.

C. Global Implementation

Recent developments in negative interest rates have been implemented globally in a selective

manner due to differently structured economies in the world and varying monetary policies

across the nations. In Europe, countries such as Switzerland, Denmark, and Sweden have

employed negative interest rates in a bid to shield their economies from potential deflationary

threats and bullets and to curb effects of capital inflows which would otherwise lead to an

overvaluation of domestic currency as indicated by Bech and Malkhozov (2016). These nations

therefore, aimed for sustainable export prices to expand their revenues as well as resisting

deflation, which can hinder growth. The policy has had some success in these respects,

effectiveness observed as it succeeded in reducing the borrowing cost and boosting the asset

prices to certain extent. On the other hand, Asia has been more careful in its approach in spite of

the fact that it has had more cases than Europe. While Japan has managed to implement negative

rates it is noteworthy that other central banks in the region often use other such methods such as

quantitative easing to deal with similar issues (Chen et al. , 2017). Such policies have the overall

objectives of expanding money supply and supplying stimulus to the economy without

employing negative rates, which signal a more cautious approach towards the use of monetary

policies. The negative interest rates is an example of how policies effects the finance since their

introduction has had the following impacts; On the one hand, they have accomplished the

appealing goal of cutting credits costs and helping to sustain asset values in many areas at the

same time give needed stimulus to sluggish economies. For instance, reduced interest rates

promote investments and credit takeoffs for businesses, while increased asset values may

promote spending due to higher consumers‟ wealth levels. This policy has nonetheless, also

raised some criticisms regarding the global banking sectors‟ soundness and profitability in the

longer run. Negative rates have the ability to give banks a sentiment of dissatisfaction due to its

impact on the ability to maintain or indeed improve the difference between lending and deposit

rates and could easily lead to a reduced capability to lend (Arteta et al. , 2016). Also, other

studies have found that the transmission of negative rates to the remaining economy has not been

impartial. There are some professional areas that have been affected to a greater extent than

others, and some countries as well. For instance, whereas large companies and financial markets

may enjoy lower financing costs, small enterprises and individuals do not get the same kind of

advantage if banks are still hesitant to charge negative rates (Ulate, 2021). This uneven impact

thus, explains why the idea of negative interest rates becomes complicated to implement on a

global market. However, public opinion also includes certain doubts, which are associated with

the possibility of negative rates distorting the markets. Due to the negative rate regime

Frankenthal argues that it leads to a search for higher return because investors are forced thereby

pushing them into riskier assets that in turn creates asset bubbles and thus increases the financial

instability. The case studies of negative interest payouts hence, indicates the need for tackling

monetary policy with specificity to local economies. Ideas that suit one area or nation could be

irrelevant in another location. The necessary measures should thus, be carefully designed, taking

into account the systemic differences in the world economies and possible consequences.

Concisely, practitioners have applauded the option of negative interest rates because it allows

central banks to defy deflation and foster spending, and yet, there are challenges that have been

mentioned about its usage, the policy impacts squarely on local work and the emerging reactions

of the broader financial system recommending caution to central banks while implementing them

to address what they witness locally.

2. Economic Theories

A. Keynesian Perspective

The Keynesian view about negative interest rates is based in the view of whether using fiscal

policy for boosting overall demand in order to counteract economic slumps and deflationary

forces. The Keynesian economic models promote the proposition that in a situation of economic

idle, monetary policies like reducing the interest rate to zero may not be sufficient to bring

demand pull inflation (Krugman, 2018). Therefore, negative interest rates have to be considered

as an expansion of Keynesian actions to lift investment and consumption in a situation when the

economy is stuck in a liquidity trap (Eggertsson et al. , 2019). Liquidity trap: During this

situation, the normal monetary policy tools become useless since the rate of interest can only be

set at the zero bound or a fraction above. Negative interest rates overcome this by setting a fee

for the money itself and thus promote spending and investing. It can help increase the total

demand for goods and may help an economy recover from a period of stagnation or decline

(Krugman, 2018). The theory supposes that when its expensive to hold cash, firms and

consumers will spend or invest or borrow, this stabilize or possibly enhance the economy and

fight deflation. The Keynesian theorists also make people aware of the demerits, the possibility

of negative consequences of negative interest rates. There is also an issue with the model involve

“zero lower bound on nominal interest rate,” that means there is a limit of how low interest rates

have to be before they actually are detrimental (Rognlie, 2016). Further, negative interest rates

may not work efficiently in the long run, since there would be lower returns to the next

incremental changes in rates. Another important concern pertains to the implications for savings

which have now been reduced and the banking sector profitability. Negative rates can also cut

deeply into profits because of a pinched net interest margin and are most disadvantageous when

loan losses are increasing and there is a consequent decrease in the ability to make new loans.

This implies that the policy might lose its potency once banks reduce the capacity to lend due to

reduced profitability (Eggertsson et al. , 2019). Moreover, negative rates could act as

discouragement to the accumulation of resources in form of savings; a move that results to

negative implications over the long-run concerning capital formation and balance of payments.

As seen from the Keynesian perspective, however, negative interest rates are not a silver bullet

as far as increasing the demands of projects are concerned. The Keynesian economists have

advocated for the use of what they referred to as assistant fiscal tools to attain specific economic

objectives. In particular, fiscal motives that require increasing expenditure and/or introducing

preferences for certain forms of taxation directly affect demand, which can be significantly

stronger, at least in specific circumstances, compared to the impact of monetary motives because

the latter often appear insufficient in conjunction with, for example, high levels of inflation

(Krugman, 2018).

B. Monetarist View

The followers of monetarists approach, initiated by Milton Friedman, underscore the impact of

money supply as opposed to interests in maintaining economic equilibrium. According to

monetarism, negative interest rates are highly questionable as their application goes against the

concept that money base and interest rates should be used to target inflation and actual GDP

(Friedman & Schwartz, 1963). Monetarists believe that economic stability can only be achieved

if the quantity of money is controlled not by using interest rates which can be sent to incredibility

levels. , the dominant school of thought on monetary policy in the US and UK known as

Monetarism posited that the practice of negative interest rates are capable of distorting financial

markets and savings practices leading to potential misallocation of resources and resulting in

deleterious effects on efficiency (Taylor, 2017). About negative interests, they argue that instead

of negative rates, central banks should pursue other mechanisms, such as quantitative easing to

create more money directly. In this way they can steer activity in the economy with the help of

refinancing rate and does not require negative rates (Goodfriend, 2016). Quantitative easing is

the process whereby the central bank buys more financial securities with the purpose of injecting

more liquidity in the economy which brings down the long-term interest rates and improves

spending and investments. Monetary growth, forecasted by Monetarists also lead to such

consequences as negative interest rates that possess a number of dangers, including asset bubbles

and financial instability. Where rates are significantly low or even negative, investors may look

for even higher returns through the purchase of riskier assets, engendering more risk-taking and

the escalation of asset prices above their rational valuation floors. This behavior leads to the

formation of asset bubbles and if these burst, there are ominous signs for the stability of the

financial system (Taylor 2017). Negative interest rates take the option of holding cash at a

certain cost, thereby deterring savings and a subsequent decline in the amount of capital in the

long run. This decline can severely impact the future economic growth as there will be less funds

for investment. Despite acknowledging the problems of a zero lower bound on interest rate,

monetarists have advocated for a long RunNS monetary policy framework, but not reaching for

the latter at a nominal zero and negative interest rate policy. Their claim is that the right

approach to managing the money supply can create economic stability and cuts down the level of

uncertainty within the markets: (Friedman / Schwartz (1963).

C. Modern Monetary Theory

The unconventional perception of the policy of negative interest rate accordance to the MMT is

considered to be a part of profound strategy of economy management. It points out, as elaborated

by MMT theorists, sovereign currency-issuing government is capable of controlling its economy

employing fiscal characteristics without the limitations typical for most of the significant

monetary systems (Kelton, 2020). From this perspective it is argued that the autonomy of

government behind fiat money means that it is not constrained as a household or a business and

therefore, has more freedom when it comes to operating with economic imperative. In this

context, negative interest rates are considered as an additional instrument to the monetary policy

framework and fiscal policy. MONETARY POLICY: They are employed in the management of

interest rates and the steering of the direction of the economy (Tymoigne & Wray, 2013). In

other words, if central banks lower interest rates into a negative territory, this will discourage

individuals from saving their money by punishing savers and rewarding borrower and investors.

This is particularly helpful during a low demand where almost all what has to be done, has been

done; such as cutting interest rates which have been at near zero. According to the advocates of

MMT sumerages, negative interest rates can be used to put the nation to work and stabilize

prices. These rates in a way can spur spending and investments hence reviving economic growth,

helping in eradicating unemployment and avoiding the occurrence of deflation (Kelton, 2020).

But as MMT notes, negative interest rates are greatly dependent on the integrated fiscal and

monetary policies to realize other objectives of the economy. Reducing inflation as a policy tool

with less application of monetary policies, including lowering of interest rates without attendant

government spending through public investment could be inadequate to foster the right volume

of economic activity (Tymoigne & Wray, 2013). The main objection to MMT has to do with the

effect that such measures may have on the idea and practice of the independence of the central

bank and the likelihood of increasing inflation (Palley, 2015). They argue that resolving too

much on fiscal policy may pose a threat to the independence of the central banks and if the

government takes fiscal measures to their extremes, the result could be high inflation.

3. Central Banks' Policies

A. European Central Bank

In June 2014, the ECB which till then, had not adopted negative interest rates, imposed a

negative deposit Facility Rate, which involved levying banks for keeping excess money in ECB.

This new regulation was should help to bring forward lending and investment by reducing the

cost of credits which in turn made banks to engage in more lending (Coeuré, 2016). It was a

decisive step in the conduct of the war against low inflation and lack of economic growth in the

Eurozone especially after the sovereign debt crisis (Frankel, 2017). Whilst negative rates are

applicable in euro area, the ECB also adopted other measures such as quantitative easing and

TLTROs. All these had been well designed in a bid to ease market conditions and enhance credit

supply to the real economy (Praet, 2017). Through sounding credit, the ECB aimed at

stimulating the economy and put pressure on the inflation rate through the availability of

sufficient amounts of money. Some scholars have argued that the proposed change may have

negative impacts on the profitability of banks and creditanst for the real economy and further

argued that the proposed change would distort financial markets (Claeys et al. , 2018). The

effects of negative interest rates on selected indicator: Negative interest rates affect the banks‟

margins where it reduces banks‟ capacity to earn profits with the goal of sustaining their role of

being financial intermediaries. However, negative rates for longer periods can cause disruption in

the financial markets and create systemic risk in the financial system by having large incentives

to take risks which are not sustainable in the long run. Nevertheless, based on the resultative

arguments, the ECB continues to assert optimistic stance that negative interest rates serve their

main purposes of raising inflation and growth (Coeuré, 2016). In addition, they have explained

that the corresponding costs of the said policies are easily outweighed by the positives,

particularly during a time that inflation remains low and economic growth remains sluggish.

B. Bank of Japan

Negative interest rates came to the world‟s and Japan‟s, more specifically, attention in January

2016 when the BoJ decided to implement it, using the interest rate on excess reserves of -0. 1%.

This decision was part of a bigger strategy that the BoJ embarked on in a bid to meet its inflation

target of 2% and also end the perennial deflation problem that Japan has been face for many

decades (Haruhiko, 2016). The BOJ adopted negative interest rate in October, 2016 while

conducting QQE/YCC, which is an effort to guide the 10-year Japanese government bond yield

to around zero percent (Kuroda, 2016). The BoJ sought to achieve these goals through negative

rates, hence cutting borrowing costs, encouraging investment, and weakening the yen with the

objective of making exports more competitive in the global market (Fukui, 2017, p. 3).

Nevertheless, the Japanese economy faced some issues relating to stabilizing inflation rate and

regaining strong economic growth, which open the discussion over the applicability of negative

rates to such setting (Shirai, 2018). Its detractors argue that factors within the framework of the

Japanese economy, including its demographic characteristics and slow rates of increase in

productivity, limit the potential results of measures related to the use of means of monetary

policy only (Ito, 2016). These structural factors therefore, affect the implementation of monetary

policy in relation to the transmission mechanism, restraining the boosting of demand and

investment. Nevertheless, there are condemnations and contentious details on the utilization of

negative interests rates by the BoJ; the policy still constitutes an unyielding and multi-faceted

approach of the BoJ in its endeavour to obtain price stability and spearhead the economic revival

(Kuroda, 2016). The BoJ opines that although there is a possibility of negative rates being

somewhat ineffective in pointing structural issues, still there exist significant uses of negative

rates in the overall framework of a monetary policy. Negative rates, together other innovative

policy measures such as QQE and YCC assist in providing favourable financial environment

since they prompt borrowings and investing. It is hence, crucial to note that moving into negative

territory in 2016 was the Bank of Japan‟s key strategy for the monetary policymaking. Although

it has not been easy for the BoJ to achieve both his inflation and growth goals, it means that it

will retain negative rate as part and parcel of an arsenal in monetary expansion tools. As the

Japanese economy continues to face multiple difficulties, experts have discussed the possibility

of constant issues with negative interest rates, and the ways in which these problems reflect the

intersections of monetary policy during the age of economic instability.

C. Federal Reserve

It is significant to note that while the ECB and the BoJ have begun setting negative interest rates,

the Fed has not made a use of negative interest rates, though it has pondered over the matter in

the process of devising its monetary policy strategies. During and after the implementation of the

global financial crisis, the Fed enacted their policy of near zero federal funds rate and highly

pronounced programs of QE to support the economy of the United States of America (Bernanke,

2017). While negative interest rates were under consideration, they were never seriously

considered as there was always sentiment that the recovery in the US was far more robust than in

most other developed countries (Yellen, 2016; Economist, 2015). Some of the Federal Reserve

governors have expressed worries about the negative outcome of the negative rates with the

regard to some dis-intermediation concerns with relation to money markets and profitability of

the banking sector (Powell, 2020). Furthermore, there is unanswered question about the

effectiveness of negative rates within the structural framework of the economy of U. S where

financial markets and institutions work differently than in Europe and Asian countries like

japan(Bernanke, 2017). Instead, the Fed has focused on using forward guidance, and thus

pinning a downward pressure on long-term interest rates, and engaging in large-scale asset

purchases in order to support economic activity (Powell, 2020). Similarly, the US Fed has not

been enthusiastic about implementing negative rates, and this general reluctance reflects another

more extensive on-going discussion within the community of central banks on the costs and

benefits inherent in the policy of negative interest rates (Yellen, 2016). Hence, the Fed refused to

set negative interest rates, as the structure of economy and the financial system in the United

States is different from that of European countries. In conclusion, there is a marked distinction

in the monetary policies that the ECB and the BoJ adopted as they implemented negative interest

rates as a tool of monetary policy, against the backdrop of the Fed that set for itself a different

strategy in light of the peculiar challenges facing the U. S. economy. Thus, the Fed‟s hesitancy to

employ negative rates suggests methodological and epistemological challenges surrounding the

implementation of UMPs based on their mixed effects, as well as a prudent and strategic

approach to protecting global financial stability and economic growth.

4. Effects on Currency Value

A. Exchange Rate Dynamics

Interest rates carry a great deal of power over exchange rates and negative interest rates are

particularly worthy of consideration as they can significantly change the value of a nation‟s

currency compared to other currencies. Generally, when a central bank decides to apply a

negative rate, its aim is to lower the domestic interest rates making the investments in them less

attractive hence discouraging investors from investing in the domestic market and instead

investing in other foreign markets (Hale, 2019). Such a shift in policy may lead to capital flight

as investors transfer capital to other countries where now there appears to be higher interest rates,

which will ultimately apply pressure on the domestic currency (Rogoff, 2019). Like any other

action affecting a national currency, the depreciation of a currency has its positives and

negatives. On one hand, a depreciated currency works to increase export levels since the prices

of domestically produced goods are more appealing to foreign consumers making exports to

have the competitive edge in the global markets (Rose, 2019). This creates demand for

domestically produced goods and services in other countries which leads to the expansion in

economies and even the possible reduction of trade imbalances. However, having a depreciated

currency might increase manufactured item prices, thus fuelling inflation and limiting consumer

spending (Frankel, 2016) The following is that through imported products, the cost of such

products goes high and this will in turn make the consumers cost of goods and services to go

high hence, eradicating their standard of living. Furthermore, there is the tendency of increased

exchange rate risk when the rates become negative and among the measures that cause negative

rates include. Increasing the rate of a country and relative rate down in another results in more

fluctuations of exchange rate due to market participants‟ expectations (Farhi et al. , 2016). It is

an unfavorable feature that can strengthen fluctuations in the exchange rate dependent on

expectations for further actions of the monetary policy and the state of the economy; it means

that growing economic instability affects the possibilities and orientations for investments and

resources‟ distributing in various businesses and companies. Moreover, exchange rate fluctuation

can also become a source of risks for investors and firms with business in foreign countries or

who possess assets valued in foreign currency, as these might cost more or less to acquire due to

fluctuations in exchange rates hence affecting their revenue and financial health. In this case,

negative interest rates affect other currencies in relation to specific factors, such as the domestic

economic performance, global economy, and differences in the policies of key central banks on

the global stage (Obstfeld, 2015). During a period of generally firmer economic growth in the

domestic economy and different monetary policies in developed countries negative interest rates

could cause a devaluation of money in the domestic economy as many investors are drawn

towards foreign countries in hopes of earning higher yields. On the other hand, during periods of

economic downturns or coordinated monetary policy decisions by major central banks or during

the current exception where many central banks are reducing rates exists, negative rates‟ impact

to exchange rates may be either dampened or even switched to positive. Therefore, the effects of

negative interest can cut across the exchange rates via direct and indirect actions as well as

possessing various intended and unintended implications. Therefore, authorities should pay

attention to impacts of negative rates on currency exchange rates, turnover and inflationary

tendencies in the given environment while developing suitable monetary policies. What is more,

the market participants have to be actively monitoring the situation and adjust strategies to the

changes regarding exchanges rates linked to shifts in interest rate policies.

B. Currency Depreciation

The possibility of negative interest rates results in concerns as adverse effects such as

depreciation of the currency is experienced given that investors look for high returns elsewhere.

Negative interest rates due to actions of a country‟s central bank reduce the returns of

investments in the country‟s currency, consequently causing investors to move their money to

assets in other countries offering better returns (Wen, 2019, p. 141). As a result, the demand for

the home money reduces its value against other monies, yet over time the demand for domestic

currency reduces (Maurer, 2018). There exist several benefits and risks that may result from the

fall in the currency value of a country‟s economy. On the positive side, it can promote export

competitiveness in two ways: first, by making domestic products cheaper for foreign consumers

through export subsidies and, second, it can aid export development by promoting economic

growth and employment opportunities (Amiti & Weinstein, 2018). Since the rate of dollar

against the Chinese RMB is down, it may make exports to the global markets attractive and may

increase the demand for domestic goods and services. This is can thus, positively impact export

revenues of firms involved and consequently stimulate overall economic growth. However, the

approach based on currency depreciation can also bring certain negative results. It can raise the

price of imported goods and services and thus result in inflation which leads to the reduction of

purchasing power of consumers(Higgins & Klitgaard, 2017). Imported inflation is therefore, a

significant problem because it alters household purchasing power, which in turn can lead to the

weakening of consumer sentiment and reduced activity levels in the economy. Furthermore,

depreciation affects borrowing costs in the global market as well as have shortcoming for the

businesses and households with FC foreign currency-denominated debt as it escalates the cost of

servicing the same debts. This could hence, lead to difficulties, containing financial problems for

entities with debts and hinder their investment and spending, so the process affects economic

development. In conclusion, the effect of currency depreciation arising from a negative interest

rate therefore on the economy depends on factors such as; the degree of openness of the

economy, the nature of the goods being exported and imported, and the exchange rate pass

through on domestic prices (Gopinath, 2016). Export-oriented nations may experience an

advantage of a low value for money as it increases nations‟ export competitiveness.

Nevertheless, one should not underestimate such negative impacts of depreciation as raised

import expenses as well as inflation risks in the course of economic considerations. This

relationship makes it particularly challenging for policy-makers when deciding on the form and

implementation of the monetary policy because they have to balance the export competitiveness

and stability of the Macroeconomy.

C. Competitive Devaluation

Negative interest rates do not alloy in competitive devaluation, which is the act of the

depreciation of a country‟s currency for a competitive advantage in trade (Evenett & Fritz,

2016). That is when central banks decrease the interest rates to below zero, that means bottom up

pressure on the exchange rate in such a manner that export becomes cheaper and import becomes

relatively more expensive (Bénassy-Quéré et al. , 2018). This trend becomes widely observable

in cases when several countries embrace negative interest rates at the same time and this results

in the weakening of the national currency in relation to other key currencies (Obstfeld & Rogoff,

2017). A strategy reminiscent of competitive devaluation refers to a situation whereby one

country engages in a war of words through its currency value so as to gain an upper hand in

selling its products at the expense of its trading partners (Krugman, 2019). They can deepen

trade tensions and lead to measures that are protectionist and may distort trade and supply links

across the globe as well as affect friendly cooperation (Baldwin, 2012). Moreover, competitive

devaluation can cause a vicious cycle where countries seek to devalue their currency for the sake

of enhancing the competitiveness of their exports despite the negative impact on their national

economies in the long-run (Borio, 2019). The obsession with achieving competitive edge through

currency debasement can lead to fluctuation within the interlinked global system of foreign

exchange and deepen global imbalances. Policy makers therefore bear the burden to well

evaluate the probable benefits of competitive devaluation against the likely resultant future

currency war, and the potential impact on the global economy (Mundell, 2018). Although the

AOA depreciation has helped to increase export sales and growth by enhancing competitiveness

through reducing the export cost, there are associated risks such as; provoking retaliation by

trading partners and causing instabilities in the international supply chain. In this contested field

of international financial relations, policymakers try to avoid adverse trends in financial

globalization and suggest strategies for constructing more desirable conditions for sustainable

and inclusive economic growth with globalization. Negative interest rates and the case of

competitive devaluation therefore, raise a question about a complex situation of the

contemporary world economy. On the one hand, rivalries over currencies threaten to intensify, so

decision-makers need to be careful in order not to compound the existing issues and preserve the

stability and sustainability of the IFS. In the cases of competitive devaluation reaching out,

Harmony and cooperation can go a long way in finding a middle ground to replace the

competition and conflict currently defining the International economy.

5. Impact on Financial Markets

A. Bond Yields

Understandably, negative interest rates can significantly influence bond yields, regarding

government and corporate debts as well. Since negative rates are set by the monetary authority of

a nation‟s central bank, discounting the bonds‟ yield lowers the potential for investors to earn

high yields elsewhere (Bauer et al. , 2016). As a result, demand for bonds increases, and prices

rise while yields decrease because people are ready to acquire bonds at higher prices for the same

rate of return. This trend is particularly obvious in countries where negative interest rates apply

to government bonds where investors are willing to overlook negative yields and risk being

locked into losses for the sake of perceived safety and liquidity (Rey, 2015). Nonetheless,

negative yields can distort the bond market and decisions of rewarding investments thus leading

to inefficiency in the allocation of capital, and increased risk taking, (Brunnermeier & Koby

2018). The desire to earn more revenues due to dwindling interest rates may force investors to

focus more on rate of return than worrying about features such as credit history or risk of default

hence compounding imbalances in the market and consequently making financial systems more

prone to turmoil. Additionally, negative yields can impose problems for institutional investors,

like pension funds and insurance companies, whose fixed-income investment plans are built to

meet long-term responsibilities (Gagnon et al. , 2016). While they may suffer from low return

rates for these instruments to meet their obligations, adjustments can occur in investment plans

or weight put on funding needs. On balance, the effects of negative interest rates on yield in

bonds depend on other aspects such the length of the bonds, the market conditions, as well as the

investors‟ outlooks (Caballero et al. , 2017). Maturity is the period between the date of issue and

the time the bond matures; it has an impact on the changes in interest rates which bonds are more

sensitive to, while market in the ease with which bonds can be bought or sold without causing

significant change in their prices. Another factor that affects bond yields is investors‟ emotion or

popularly referred to as Investors‟ sentiment, which depends on factors like the economic

forecast and central-bank actions. To particularise, negative interest rate can significantly alter

structure of the bond markets, change the dynamics of the bond price-yield relationship, and

impact the behavioural strategies of investors.

B. Stock Market Reactions

When it comes to the assessment of stock market reactions and equity prices, negative interest

rates may also have a substantial effect and influence the behavior of the investors. When central

banks lower interest rates below zero, then their implications is to foster economic activity and

enhance the value of the assets such as stocks ( MISHKIN FREDERIC S. , 2018). Reduced

interest rates then reduce the cost of capital and make equities more attractive relative to fixed

income assets hence stimulating demand for stocks (Boivin et al. , 2016). Moreover, negative can

lead corporations to utilize cheap funds from borrowings for share repurchases and dividends

that in turn support the stock market (Draghi, 2019). Nonetheless, the impact of negative rates on

share markets is not always straightforward as it varies with expectations and the economic

climate at the time (Gruber et al. , 2020). Specifically, negative rate may be interpreted as debt

levels warning, a sign of economic weakness or uncertainty leading to heightened volatility and

risk aversion among investors (Clarida, 2016). Also, negative rates may lead to discrepancies

over the earnings multiples of the equity market, leading to asset mispricings (Liao et al. , 2017).

Thus, the search for higher returns when accompanied by low interest rates may increase market

distortions by focusing less on the underlying value and even the market fundamentals more, and

make financial systems more prone to volatility. Nevertheless, it is unequivocal that stock

market reactions towards negative interest rates are complex and depend on a great number of

factors, including market perceptions, corporate performance, and macroeconomic factors

(Cochrane, 2016). Negative rates have shown the potential to pull up stock prices as they help to

lower cost of funds and enhance corporate activity but on the flip side, the negative rates lead to

uncertainty and market distortions which may lead to severe outcomes for investors and financial

stability. It is in this light that policymakers and market participants need to be careful in

managing the alternative to avoid having to deal with some of the challenges observed in the

global economy when negative interest rates emerged, while at the same time bearing in mind

possible effects of negative rates on stock market performance. The three attributes, therefore,

remain critical in managing risk paradigms and protecting the fabric and robustness of equity

markets under low- interest rate conditions.

C. Derivatives Market

Specific examples of contracts that react strongly to changes in interest rates and negative rates

are derivatives like the interest rate swaps and interest rate futures. If interest rates turn negative,

it can create problems in the models used for derivatives as well as effect behaviours assumed in

the models (Scholes, 2016). It may further complicate the determination of the fair value of

derivative financial instruments of business and make the pricing models to have more

probabilities of uncertainties. Further, negative rates create new issues regarding hedging for

those portfolios which have long standing impacts of interest rates changes (Driessen et al. ,

2018, p. 5). For example, whenever interest rate swaps used by institutions for hedging position

against higher rates business some problem arise in the management of exposures in a negative

rates environment as noted by Sims (2017). The yield curve and the sustainment of low or even

negative interest rates can jeopardise previous hedging models, which requires searching for new

directions to hedge risks. Negative rates can also affect the valuation of options and other

derivative absolute values because they increase the cost of carry and discount factors used in the

option pricing models (Hull, 2018). Negative interest rates pose a challenge and when combined

with volatility, various studies have pointed out that there can be shifts from theoretical option

price to market price. Furthermore, negative rates enhances counterparty credit risks in the

derivatives market, since, as Bilson (2017) argues, when counterparty faces negative economic

reality, there is high likelihood of defaulting on their obligations in the over the counter market.

The problem of credit risk is more pronounced in different organizations, and therefore there is

need to place enhanced measures that will protect them as well as be sensitive to the credit

standing of the counterparties . In summary, negative interest rates pose specific risks and

opportunities for the derivatives market: Negative Interest Rates and Derivatives Risk

Management and Pricing and Hedging Implications In essence, the derivatives market is not

immune to the impact of negative interest rates and thus requires proper risk management in

addition to modifying pricing models and hedging techniques (Benninga et al.

6. Banking Sector Implications

A. Profitability Concerns

The issue of negative interest becomes a real problem for many banks – let alone old schools of

thought on banking where income principally comes from interest earnings (Cecchetti &

Kharroubi, 2015). As central banks started implementing negative rates, the centrality squeeze

threat becomes direct whereby banks feel the pinch on their NIM compression. This form of

compression in NIM can greatly reduce the profitability of monetary adds for banks in the worst

possible way if the institution cannot pass on negative rates to depositors because of high market

competition or restrictions from the legislation on increasing the interest rates (Buch et al. ,

2017). Furthermore, negative rates compounded the problems in low-interest-rate situations,

which are; weak credit demand and increased rivalry among banks to secure high-quality

borrowers (Beck et al. , 2019). In such a situation, banks experience strains in sustaining

profitability on loans as the lending rates are reduced with a compromise on the income

generated from the deposit side. In this regard, such establishments can cut operating expenses

via subsequent downsizing like minimizing the number of branches, as a way of protecting

profitability (Caruana, 2017). Moreover negative nominal interest rates destabilize saving

because savers may search for alternatives other than putting their money in bank than having it

erode. This is can actually culminate into deposit outflows, a situation that worsens the

profitability issue of the banks (Borio and Zabai, 2016). Moreover, negative rates discourage

new deposits because, instead of keeping their money in a managed deposit flight or earning

negative returns, people will either hold cash or use other means to safeguard their money. Long-

drawn age of negative interest rates means there is a system risk to the banking industry health

and entails a reinvention of the industry models and plans (Demirgüç-Kunt et al. , 2018). Thus,

there are concerns that banks need to search for new sources of funds to replace traditional

sources such as interest income earned on loans as well as diversified income opportunities,

including charges for services provided as well as wealth management services. Technological

advancement and digital dispositions of activities can also add value by increasing efficiency and

decreasing operational costs that could work well for the banks in the prevailing unfavourable

operating environment. To counter the negative effects, banks may therefore, have to reconsider

their risk appetite and potentially look into diversification as a means to ensure sustainability of

the business. It may thus, entail venturing into different areas such as new geographic locations,

new products and services, or launching into risk layer diversification in loan facilities or

participation in fee-based activities like investment banking and securities dealing. Engagement

with the counterparts in the regulators and policymakers is critical to address structural issues

and develop a sustainable model for the banking institutions under permanently low or negative

rate environment. Rules that could improve the environment in which non-M Kens operate –

recalculation of capital standards, the introduction of seismal measures – can ensure banks go

through the impact of negative rates. Action and orchestration management are thus, critical for

the survival of banks during the extended period of negative interest rates.

B. Lending Practices

Negative interest rates have numerous implications on banking operations specifically

concerning ways of credit extension to borrowers or consumers (Jiménez et al. , 2019).

Ordinarily, the lowered interest rate ought to elicit borrowing and investment activity which, in

turn, would help to boost economic activity (Demiralp & Eisenschmidt, 2019). However, Jordà

et al. (2019) note that in a real world setting, the pass through of negative rates to the lending

rates can be dampened by profitability motives, risk considerations and regulations. Negative

rates pose some risks for banks as they could lead to reductions in their NIM over time;

therefore, the extent to which negative rates reduce lending could vary depending on how banks

seek to maintain their profitability: For instance, the banks might become more selective in their

lending, focusing more on the low-risk clients or sectors in order to minimize their risk of default

(Gropp et al. , 2020). In particular, selective lending may lead to credit squeezes for risky

individuals or sectors, who face difficulties in obtaining funding and losing access to fresh

capital, and thus might be locked out of potential investment and expansion. Also, credit

markets can be misaligned, which in turn, means that capital will be misallocated and leverage in

some particular industries can be accentuated through negative rates (Altavilla et al. , 2019).

Farmakis, in his quest to seek yield given the low interest rates, companies are able to issue more

debt in order to finance non-Financial investments such as share repurchase or dividend payouts

as opposed to productive capital investments (Altavilla et al. , 2019). This leads to further asset

price bubble formation and a compounding of sources of financial fragilities. Furthermore,

negative rates can encourage reckless lending in an effort to achieve larger profits margin at the

cost of creditworthiness, which in turn elevates the likelihood of stability in the system (Buch &

Goldberg, 2017). CRA aggressively lends in a low-yield environment leading to increased

lending credit especially to risky borrowers and hence more risky assets conveyed to the balance

sheets implying higher shock rates for the financial system. In more detail, the concept of

negative interest rates may also appear paradoxical as an approach to stimulate lending activity,

with its effectiveness depending on the market conditions, banking risks, and regulatory

requirements during their implementation in practice (Hannan & Stein, 2017). Local policy

makers have to closely pay attention to the consequences of negative rates on lending activities

and financial stability in a country, thus, involving measures to prevent possible credit risks and

responsibly provide credit instruments in the economy.

C. Financial Stability

It has been ascertained that negative interest rates can indeed have advanced effects on the

financial stability since they affect the banking and overall financial structures (Brunnermeier, et

al. , 2020). Concern arises when there is a long-term application of negative rates due to negative

impacts on the strength of banks and their balance sheets by detracting from profitability and

capital adequacy, which would compromise their buffer against losses and credit risk during the

risky phase (Acharya et al. , 2019). The consequences of negative rates for net interest margins

(NIM) threaten profitability of the banking industry: banks „compressed‟ net interest margins

(NIM) due to negative rates reduce the flow of interest income through increasing revenues from

higher-yielding assets (Draghi, 2017). This search for yield can encourage risk taking among

banks, which can lead to under-pricing of risks; in other words, banks build up risks in the

system (Köhler et al. , 2019). Moreover, negative interest rates impact other sectors of financial

institutions like insurance firms and pension funds through their activities indicating that they

hold huge volumes of fixed income instruments in order to meet their liabilities (Pozsar et al. ,

2017). These institutions may fail to generate lucrative profits at such low rates thereby putting

solvency of these institutions at risk (Bennett & Schularick, 2019). Therefore, negative rates

have negative impacts on the overall financial system and may lead to financial system risks and

at the same time may worsen the system‟s fragilities. Furthermore, they reason that negative

rates create negative impacts on financial markets and consequences on the effectiveness of price

mechanics such that they alter market structures and increase fluctuations (Borio, 2019).

Investors in search of yield do so in low-interest-rate conditions may place their investments in

risky assets including helping in the formation of asset bubbles and cyclical market imbalances.

In general, the negative interest rate policy, though might give short-term push in the economy,

entails variety of threats to financial stability in the long run, and therefore, should not be

implemented carelessly, but rather under the strict supervision and coordination with several

authorities recommended by Hanson et al. (2019). Negative rates also bring some risks to the

financial stability, thus policymakers should analyze beneficial and adverse effects of negative

rates and develop appropriate measures to minimize possible negative impact. This may range

from improving the quality of prudential regulation, improving supervision and ens MB

monitoring of financial institutions, and supporting better transparency and disclosure in

financial markets.

7. Global Trade Consequences

A. Trade Balances

Interest rates also have an indirect influence of a considerable nature in such things as various

balances in the global economy such as trade balances due to several interrelated factors such as

exchange rates and the relative cost of exporting and importing goods and services (Obstfeld &

Rogoff, 2017). This is usually used in a bid to influence exporting capabilities; currently, several

central banks have enacted negative interest rates on currencies (Frankel, 2016). Depreciation of

domestic currency becomes as the outcome that stimulates exports while simultaneously

reducing import demand, which would help to eliminate the trade deficits (Mundell, 2018). This

process is styled in the following manner: the domestic currency weakens and in turn, the export

goods become less costly for the foreign purchaser in international terms. This, in its turn, can

cause a rise in the import side‟s demand for the domestically-produced production of goods and

services, resulting in increased export volumes. On the same note, it also make imported goods

and services relatively expensive to citizens and business from the originating country hence

may reduce their demand towards the foreign products. Thus, exports would grow faster than

imports, and therefore the trade balance would be positively affected giving a surplus that

improves the trade balance. Nonetheless despite the leverage that low interest rates have on

influencing trade balances through depreciation of the country‟s currency, it often has has the

following complications. One of these is the mix of exports and imports of a country since this

constitutes one of the most significant factors that leads to the realization of the effects of FDI. It

is therefore possible that export fluctuations arising out of exchange rate changes may be

considerably constrained if a large proportion of the exports are of non-essential goods or

services that have low out-turn elasticity of demand. Likewise, if a country depends on import

for essential consumption or dictates non-salable products, the decline in import need may not

compensate for the benefits of improved export competitiveness. A stretch in demand from

overseas moreover, plays a critical role in determining when low-interest rates spur or affect

trade balances. Where foreign consumers or businesses are sensitive to changes in relative prices,

depreciation of the domestic currency can lead to a rise in exports in extents larger than the

impact on the trade balance. Furthermore, the way in which exchange rates volativity affect

relative adjustments in the prices of imported and exported goods referred to as exchange rate

pass through mechanism play a vital role in determining the performance of low interest rates in

altering trade balances (Levchenko & Zhang, 2016). Alternatively, where depreciation or

appreciation occurs, if exchange rate variations are fully passed through to import and export

prices, the impact on trade balances appear to be more significant. Nevertheless, this form of

incomplete exchange rate pass-through can dampen the effect of low interest rates on the trade

balances and therefore make their utilization in addressing imbalances ineffective. In other

words, it is also worth stating that an ability of low-interest rates for exports‟ stimulation and

improvement of trade balances means depreciation of own currency deeply depends on a range

of factors, such as the structure of exports, the elasticity of foreign demand, and pass-through

rates of the exchange rates. These factors therefore, need to be given due consideration while

applying interest rate differential strategies, designed for improving export capacity and

correcting trade deficits. However, to enhance the effects of lower interest rates on the balances

of trade and other reserves, it may be necessary to back it up with corresponding measures.

B. Export Competitiveness

This is expected to make export goods more competitive since the cost of producing the goods is

decreased by way of negative interest rates thus making the domestic output cheaper for the

foreign buyer. Working through the depreciation of domestic currency purposely brought by the

central bank of a certain country once it implements the negative rates makes exports more

inviting and competitive in the global market (Amiti & Weinstein, 2018). One of the effects of

trade opp tunnels is an increase in export volume and share in the market since buyers from other

nations prefer locally manufactured goods and services due to their relatively low price

translation. This increase in demand for exports can lead to the creation of more employment

opportunities in export industries thus boosting domestic economic growth and development. In

addition, through negative rates, firms can take advantage of the reduced cost of capital and

invest in profiting exporting sectors to increase improved their competitiveness in the global

market (Krugman, 2018). However, the assumption made here is that export competitiveness

received from negative interest rates has it positives, which may however be reduced by several

factors. Global demand conditions also pose a major shift such as; A change in demands

requirements can affect the opportunity for countries to capitalize on competitiveness. Similarly,

trade barriers or distances in the supply chains may make it challenging for exporters to benefit

efficiently from the depreciated currency (Altavilla et al. , 2019). Finally, it also exposes

weaknesses regarding the sustainability and longer-term impact of negative interest rates as the

means for achieving enhancement of export competitiveness is dependent upon other

macroeconomic and geopolitical factors (Gopinath, 2016). Long-term declines in currency

values, for example, may lead to apprehensions among trading partners that the particular

country is engaging in „currency manipulation,‟ which may lead to adverse trade policy

responses and even protectionism (Evenett & Fritz, 2016). Such developments can adversely

affect the stability of export and import relations and prevent the achievement of the ultimate

positive effects of negative interest rate environments, export competitiveness, in international

trade. Negative interest rates are helpful therefore, enabling export competitiveness from a

positive perspective, not only imposing challenges and risks but also holding certain benefits and

thus, opportunities for export competitiveness in the negative perspective in the long run.

Although they may indeed work wonders when it comes to the appeal and viability of exports by

cutting the costs of production and thus making the domestically produced goods more appealing

and easily accessible to foreign buyers, their efficiency and sustainability is most often than not,

dependent on a plethora of factors imposed by the world economy that include global demand,

trade barriers and such geopolitical factors as global tensions. This therefore, means that the

adoption of negative interest rates should be accompanied by measures that will help minimize

adverse effects potentially linked to the practice while maximizing positive impacts required to

enhance export competitiveness and thus, support the growth of the country‟s economy.

C. Import Costs

Presumably, negative interest rates may affect imports through an impact on import costs by

affecting exchange rates as well as prices of imported goods and services (Higgins & Klitgaard,

2017). Negative rates also mean that whenever the central bank of a certain country set this

policy, there is usually a depreciation of the local currency and this makes imports for the

domestic consumers and firms relatively costly than before (Chinn & Hiro, 2019). Such an

appreciation effect could mean that a company‟s import prices go up reducing the buying power

of the consumers which may culminate in inflationary pressures (Frankel, 2016). Negative

interest rate barely influences the export prices as it has a positive impact on the domestic

currency thereby implying that an increase in price of imports may be experienced. An increase

in import prices means that domestic consumers and/or businesses may need to spend more on

imported goods which in turn affects their consumption or expenditure. This, in turn since it can

drive up the general price levels it is likely to add to or lead to inflation within an economy. In

addition, negative interest rates entail distortion of import mix since firms undertake measures to

counter the effects of depreciation of the currency. As a result of the high costs of imports, firms

respond by using more locally produced products rather than imported ones, which means that

the composition of imports in relation to local manufacturers is likely to change (Gagnon et al. ,

2016). This change in product import composition may have significant implications for national

industries and citizens, as it may alter the structure of the markets within which these industries

operate. Nevertheless, the fact is that negative interest rates have some impact on the cost of

imports in various degrees. They thus, include factors such as the extent of pass-through from

exchange rate changes to import price levels. Where changes in exchange rates are translated to

import prices instantly and in its totality, the pressure on the costs of imported goods may be

higher. On the other hand, if exchange rate pass-through, which is the extent to which changes in

the exchange rates are reflected in domestic prices of imports, is incomplete, then the negative

rates‟ impact on the costs of imports may be diluted (Fratzscher, 2019). Also the degree of price

sensitivity of such products through interaction of import costs with the elasticity of demand and

existence of domestic substitutes influences the degree of impact of negative rates. relative

inelasticity of demand. In cases of import price fluctuations, where the demand for imported

goods has more or less remained quite inelastic, consumers may not be very sensitive to price

changes due to depreciation of their currency. In the same way, availability of close substitute

domestic products can prevent the egregious effect that may accrue from high import cost on

consumers and other firms (Bénassy-Quéré et al. , 2018). In addition, fluctuations in the costs of

imports due to negative interest rates may also have implications for industries that have use

import inputs and materials, especially for manufacturing. Increased cost of imported goods

could lead to increased cost of manufacturing in these industries which can affect its

competitiveness and profitability. Furthermore, these cost hikes could be incurred by consumers

through higher prices set by businesses, which are likely to exacerbate inflationary forces in the

economy according to Maurer (2018). It can be therefore be stated that, negative interest rates,

can thus affect import costs in terms of exchange rates, however other variables and policies can

also play a crucial role. This is where the conjoint factor of pass-through of exchange rates to

import prices, demand elasticities of imported products, and availability of domestic substitutes

determine the total import cost impact of negative rates. These considerations therefore, require

that policymakers need to weigh them when evaluating the import implications of negative

interest rate policies while developing an adequate policy response to any adverse shocks.

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IMPACT OF NEGATIVE INTEREST RATES ON INTERNATIONAL FINANCE

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