Download negative interest rates

Aswath Damodaran
NEGATIVEINTERESTRATES:
IMPOSSIBLE,IRRATIONALOR
JUSTUNUSUAL?
March2016
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NegativeInterestRateCurrencies:Central
BankandMarketRates
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10-yearGovernmentBondRates:By
Currency(March9,2016)
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InterestRates101:AnIntrinsicInterest
Rate
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InterestRates101:AMarketSetRate
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IntrinsicversusMarket-setInterestRates–
ConvergenceandDivergence
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TheCentralBank’sInterestRatePlays
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NegativeInterestRates
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Theconventionalviewofnominalinterestratesisthat
theycannotbenegative,sinceyouhavetheoptionto
holdcash(ratherthansaveitatnegativerates).
Thisisbasedonthepresumptionthatholdingandusing
cashiscostlessandthatmaynotholdfortworeasons:
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Storingcashmayrequiresecurity (anditscosts).
Usingcashforsome transactionsmaybeexpensive andperhaps
infeasible.
Ifyouintroducecoststoholdingandusingcash,nominal
interestratescanbenegative,albeitwithalowerbound,
sinceatsomeinterestrate,itwillbelessexpensiveto
holdcash.
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TheEffectofInterestRatesonStockand
BondPrices
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InterestRatesandtheRealEconomy
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TheHubristicBanker
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TheRealWorldBanker
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ERPandRiskFreeRates
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Dealingwithnegativeinterestrates
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1.
Switchcurrencies:Ifthecurrencythatyourcompany
reportsfinancialsinhasanegativeinterestrate,switch
toadifferentcurrency.
Caveat:Youcanrun,butyoucannothide.
2.
Normalizeriskfreerates:Replacethecurrent(negative)
interestratewithanormalriskfreerate,obtainedfrom
eitherhistoryorfundamentals.
Caveat:Normalization isintheeyeofthebeholder.
3.
Staywiththenegativeriskfreerate:Usethenegative
riskfreeratebutmakesurethatyourother
assumptions(nominalgrowth,riskpremiums)are
consistentwithadeflationary,no-growtheconomy
withhighriskpremiums.
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ImplicationsandConsequences
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1.
2.
3.
4.
Badnews:Negativeinterestratesareincompatible withahealthy
andgrowingeconomy.
Insanity,ImpotenceorIrrelevance? Centralbankshavelowered
ratesoverandoverinthelastsixyearsandhavenotbeen ableto
nudgeeconomies outoftheircomas.Buttheykeep doingit..The
veryfactthattheykeep goingbacktothislever isasignalof
impotence onthepartofpolicymakers.
Unintendedconsequences:Investorswhodesire (andneed)fixed
income fromtheirinvestments increasingly havetolook further
andfurtherawayfromtheirpreferred domains forthatfixed
income. Thepotentialforscamsandinvestment painisimmense.
Digitalcurrencies:Totheextentthatcentralbanksmake it
unattractivetosavetheircurrencies, theyarecedinggroundto
digitalcurrencies.
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