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When Interest Rates Go below Zero

Edited By; Gokul S

Monetary policy is a layered and complex instrument that governments and central banks employ to steer their economies. Standard monetary policy typically involves adjusting interest rates to control inflation, stimulate economic growth, and maintain financial stability. However, in recent years, there has been some global interest surrounding negative interest rates. While this has primarily remained contained within academic literature, there have been instances of this being used in real-life policy. This article explores the concept of negative interest rates, their impact on monetary policy, and the experiences of two countries that have adopted this unconventional strategy: Japan and Sweden.

Understanding Standard Monetary Policy

Before delving into the economics of negative interest rates, it's essential to understand the foundation of standard monetary policy. Central banks, such as the Federal Reserve in the United States, the European Central Bank, or the Reserve Bank of India primarily use interest rates to manage their economies. One of the primary objectives of central banks is to keep inflation in check. By raising interest rates, they can reduce consumer spending and investment, which can help cool down an overheating economy and prevent excessive price increases.

Conversely, lowering interest rates stimulates economic activity. When interest rates are low, borrowing becomes cheaper, encouraging businesses and individuals to invest and spend more, which can boost economic growth.

Over the past few decades, many economies have faced periods of prolonged low interest rates due to factors like sluggish economic growth, demographic changes, and global economic dynamics. During these times, central banks often resort to unconventional monetary policies, such as quantitative easing (the purchase of financial assets like government bonds to inject liquidity into the financial system) and, as this article will discuss, negative interest rates, to stimulate economic activity.

Negative Interest Rates: A Conceptual Overview

Negative interest rates represent an extraordinary monetary policy tool where central banks set key policy rates, such as the deposit rate, below zero. This means, that commercial banks are charged for holding excess reserves at the central bank. Simply put, instead of earning interest on their reserves, banks incur a cost for keeping funds idle. The rationale behind negative interest rates is to incentivize banks to lend money rather than hoard it. When banks are charged for keeping excess reserves, they are more likely to lend to consumers and businesses- stimulating economic activity and potentially warding off deflation.

Two countries that have ventured into the uncharted territory of negative interest rates are Japan and Sweden. Japan primarily aimed to combat deflation and stimulate economic growth. While there was some success in spurring economic activity, Japan continues to face deflationary pressures.

Sweden focused on preventing deflation and keeping its currency competitive. It achieved moderate success in boosting inflation but also encountered concerns about financial stability. This article shall now delve deeper into each of the aforementioned cases.


Japan's experience with negative interest rates dates back to 2016 when the Bank of Japan (BOJ) lowered the interest rate on excess reserves held by commercial banks to -0.1%. The move was part of a broader effort to combat deflation and revive the country's stagnant economy. The impact of negative interest rates in Japan has been mixed. On the one hand, they did lead to lower borrowing costs for consumers and businesses, spurring economic activity. On the other hand, banks faced the challenge of navigating the unfamiliar terrain of negative rates, which squeezed their profitability. Moreover, the intended inflationary effect was not as pronounced as desired, and Japan continues to grapple with low inflation.


Sweden first experimented with negative interest rates back in 2009, then moved away from negative rates in 2010 and implemented them a second time in 2015. The primary objective of the 2009 implementation was to address the severe economic downturn caused by the global financial crisis. At that time, the Riksbank, Sweden's central bank, reduced its repo rate to -0.25%. However, by 2010, Sweden had started to recover from the crisis, and the Riksbank began to raise interest rates once again. In 2015, Sweden once again entered the realm of negative interest rates, reducing the repo rate to -0.25%, this time to combat low inflation and prevent the appreciation of the Swedish Krona.

While Sweden's experience with negative rates has been somewhat more successful in preventing catastrophic deflation like Japan's, it is worth noting that Sweden’s economy is backed by the Eurozone, and has protections the way the Japanese economy doesn’t. Moreover, while the country saw a boost in inflation and a weaker currency, which benefited its export-oriented economy, ultra-low interest rates also led to increased debt accumulation by households and corporations and led to a staggering rise in the price level of the housing market in the country. Most importantly perhaps is that The Cato Institute concluded that while the long-term economic impact of negative interest rates is yet to be evaluated, at this early stage, the costs to Swedish society of negative interest rates most likely exceeded the benefits.

Some key takeaways from Japan’s and Sweden’s experimentation with negative interest rates include:

  • Timing Matters: The effectiveness of negative interest rates depends on timing. Japan introduced them at a time when deflation had become entrenched, while Sweden first used them as a crisis response and later as a tool to prevent deflation.

  • Side Effects: Negative interest rates may achieve their intended goals but can have unintended consequences. In both countries, concerns about financial stability and the profitability of banks emerged.

  • Mixed Results on Inflation: Negative interest rates did not always lead to the desired levels of inflation. Other factors, such as global economic conditions, also play a significant role.

  • Sectoral Impact: While banks may suffer, borrowers typically benefit from negative interest rates. Central banks must carefully weigh the overall economic impact.

Negative interest rates represent a novel approach to monetary policy, challenging conventional economic wisdom. However, the experiences of Japan and Sweden, with Sweden's unique history of implementing and retracting negative rates, illustrate that there is yet to be empirical evidence suggesting that negative rates can have widespread success in achieving their intended goals. As central banks continue to explore unconventional policies to navigate economic uncertainties, it is crucial to carefully evaluate the long-term implications of negative interest rates on financial stability, the banking sector, and overall economic health. The road ahead in the world of monetary policy is uncertain, and the debate over the merits and drawbacks of negative interest rates will undoubtedly continue to evolve. Ultimately, as economies face new challenges, policymakers must remain adaptable and open to innovative solutions in the ever-changing landscape of global finance.

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