Going Sub-Zero at Your Local Bank

Economists used to say it was impossible for nominal interest rates to fall below zero. If that ever came to pass, they argued, depositors would end up paying banks to keep money in their savings accounts, borrowers would be receiving rather than paying interest, and who knows what would happen to the banking software that can’t handle negative interest rates in their calculations. In theory, people would pull all their cash out of the bank and put it under grandma’s mattress or bury it in a Yuban coffee can in the back yard, where they wouldn’t have to pay to hold it. It would practically tear a hole in the economic universe.


Well, the pigs are flying now, and the so-called “zero lower bound” is getting breached. It’s giving economists one of those rare pinch-me moments, when they get to see how theory plays out in real life. In the U.S., the economy is growing and the Fed says it will raise rates later this year. But the European economy continues to disappoint, and interest rates are reaching unheard-of lows. The intense uncertainty surrounding the Greek economy and the Greek debt negotiations are only increasing the dangers of a European economic slump.

Several of Europe’s central banks have resorted to cutting key rates below zero to boost their economies, and it turns out that the impossible is possible. Some banks in Germany are charging customers to save money, according to the Financial Times. A bank in Spain is now paying interest to some mortgage borrowers, according to the Wall Street Journal. In Denmark, the same thing is happening — banks are paying borrowers to take loans. And in Switzerland, pension funds, “fed up” with paying banks to hold their money in regular accounts, are thinking about making massive withdrawals, according to another report.

Negative interest rates have other side effects, too. For one thing, central banks lose a tool for expanding the money supply, because they can’t lower interest rates any more. And investors become more likely to raise their risk tolerance as they hunt for higher yields. One need only reflect on the events of 2007 and 2008 to understand what happens when risk tolerance gets too high.

But one thing everyone is learning from this is that in the real world, there is indeed life below zero — that is, people aren’t actually making a run for the coffee cans and Sertas just yet. Incredibly, the money is staying in the banks.

“How can we make sense of that? If people aren’t converting deposits to currency, one explanation is that it’s just expensive to carry or to store any significant amount of it. Therefore, the true lower bound is some negative number: zero minus the cost of currency storage,” writes Bloomberg View and Vox contributor Evan Soltas.

In other words, part of the bizarre, upside-down beauty of negative interest rates, where the irrational becomes rational, is that most people will still keep money in the bank for the sake of convenience — even when they know their accounts will lose value. After all, the alternative involves getting the shovel every time you want to pay the insurance bill.

So now the question is: when does the cost of storing money become higher than the usefulness of having cash? In Europe, where interest rates continue to fall, we may soon find out.