Negative interest rates are coming! And they may be here to stay. To explain the situation I make use of simplification for clarity’s sake. Basically this is the tale of two opposing economic forces: capitalist spirit versus time preference. And basically, there are two types of people: ordinary people and capitalists(1).
Ordinary people suffer from a condition called ‘time preference’. It makes them spend their money on frivolous items sooner rather than later. Ordinary people will only forego stuff in the present if they can get more stuff in the future. Hence, interest rates need to be positive to make them save.
Capitalists on the other hand are special people. They suffer from a condition called ‘capitalist spirit’. They believe that money spent of frivolous items is money wasted because if you invest instead, you end up with more money in the future that you can invest again. They keep on saving and investing, even when interest rates are low.
What’s the point of that? The capitalists invest in the corporations that make the frivolous items ordinary people buy. And because ordinary people would have spent their money on frivolous items, these items wouldn’t have been produced in the first place. And so capitalists can be very useful.
But there is a problem. For most of history, returns on capital were higher than the economic growth rate.(2) This can’t continue forever because returns on capital would take a growing portion of national income. In the past this issue was often resolved by economic depressions and wars that destroyed a lot of capital.
Negative interest rates are the alternative to economic depressions and wars. The miracle of Wörgl demonstrates that negative interest rates could have ended the Great Depression.
In recent decades the economy was propped up by allowing ordinary people to go deeper into debt. If ordinary people stopped borrowing, interest rates were lowered so that they could borrow more to buy more frivolous items. But interest payments on debts reduce the income of ordinary people and increase the income of the rich. And now negative interest rates may be needed to keep the economy from collapsing.
Strangely enough, negative interest rates are not only a sign of capitalists having difficulty finding profitable investments, but also a sign of trust in the financial system, central banks and borrowers, because investors prefer losing money on government bonds and bank accounts to buying gold. This is an issue most economists seem to ignore.
There is so much that can be said about negative interest rates. Apart from ‘time preference’ and ‘capitalist spirit’ there are other factors contributing to negative interest rates. Negative interest rates can help to make the economy sustainable, reduce income inequality, provide liquidity in financial markets so that financial crises happen less often, and banning interest once interest rates are negative could remove risk from the financial system because interest is a reward for risk.
(1). Sapiens: A Brief History Of Humankind. Yuval Noah Harari (2014). Harvil Secker.
(2). Capital in the Twenty-First Century. Thomas Piketty (2013). Belknap Press.
Further reading on why interest rate go negative and how the future financial system might look like: