Asset bubbles may be the unintended result of a negative interest rate regime, an increasingly common monetary policy in some developed nations.
Interest rates are generally assumed to be the price paid to borrow money. Negative interest rates refer to the case when cash deposits incur a charge for storage at a bank, rather than receiving interest income.
When financial institutions have excess money, it does not make sense to incentivise deposit taking by giving interest to depositors. By the same logic, it does not make sense to lend money to borrowers and having to pay interest to them. That is the basic theory in an economy that has too much money. In this region, we have not seen this happening, although for a long time Singapore has been under a very low interest climate due to its strong currency and stable environment. For example, an annualized 2% interest rate on a $100 loan means that the borrower must repay the initial loan amount plus an additional $2 after one full year. On the other hand, a -2% interest rate means the bank pays the borrower $2 after a year of using the $100 loan. And it’s also unusual because the lender will have to bear the risk of a loan default on top of having to pay interest on the loan it is giving.
THE SITUATION IN EUROPE AND JAPAN
Central banks, however, in Europe, Scandinavia and Japan, from 2015 have implemented a negative interest rate policy (NIRP) on excess bank reserves in the financial system. This unorthodox monetary policy tool is designed to spur economic growth through spending and investment as depositors would be incentivized to spend cash rather than hoard it and incur a guaranteed loss. It has yet to be seen if this policy will work in practice, and whether negative rates will spread beyond excess cash reserves in the banking system to other parts of the economy.