Question

How can rates go negative?

Answer 1

Please see below.

Explanation:

There could be circumstance when rates become negative. Before we answer his question, we need to know what we mean by negative.

One meaning could be a change of direction i.e. if one travels `5` miles east and then `3` miles west, one can say one has traveled `-3` miles signifying movement of `3` miles west instead of in east direction. Similarly, it could be receiving `3` dozen oranges or giving say `2` dozen oranges. The latter may be considered as receiving `-2` dozen oranges.

In such cases, though direction of movement or payment may change but still one mile will remain equivalent to `1760` yards and dozen will mean `12` pieces and one cannot say rate is negative.

However, taking another example, assume a seller of eggs sell eggs at a rate of `$3` per dozen. However, if he is not able to sell all of his eggs, once eggs have become rotten, he agrees to pay `$1` per dozen to somebody who takes away the rotten eggs and disposes them appropriately. We can call such a rate a negative rate.

In fact these days, some central banks have moved or are contemplating to move towards negative rates of interest to revive their economies.

The reason is that they want industrial and commercial units to borrow money from them and in place of paying any interest receive interest. In reality as central banks lend only to banks and the latter add their operational charges, the real cost to individual industrial and commercial units may not be negative, but their cost of borrowing will come down and may be economy would revive.