The recent discussion by Stephen Poloz of charging negative interest rates to chartered banks on their deposits at the Bank of Canada was preceded earlier in the year by stories about negative interest rates on bonds in Europe. If February 2015, a Globe & Mail story reported on negative interest rates on government bonds issued in Germany, Denmark, The Netherlands, Austria, Switzerland and Sweden.
While negative interest rates seems counterintuitive, they make perfect sense if a student is thinking about the value of liquidity. We usually describe liquidity preference in terms of our willingness to forgo (positive) interest earned on bonds to hold cash. Cash may not pay interest, but it also does not have the risk associated with bonds. It may be better to earn no interest than to lose the entire value of your saving!
Government bonds are among the least risky investments in the bond market, and nervous investors are willing to pay to hold these bonds. The story has a good list of reasons, including:
- “Risk-averse investors might accept a negative yield as a sort of insurance premium to keep their money in a relatively safe and liquid debt instrument, as opposed to in a shaky bank.”
- In a deflationary environment, the real – or inflation-adjusted – return on a bond with negative nominal interest could still be positive. For example, if a bond is yielding negative 1 per cent, but the consumer price index falls by 2 per cent, the investor’s purchasing power would still increase.”
- If yields fall further into negative territory, the investor could make a capital gain because the price of the bond – which moves in the opposite direction to the yield – would rise.”
- “The investor might be speculating that the currency in which the bond is denominated will rise.”
This story, and the list of reasons, allows you to talk to students about many core topics related to money – liquidity, the inverse relation between bond prices and interest rates, deflation, real rates of return, rate of return parity, exchange rates, and speculation.
The willingness to pay to hold a relatively safe and liquid asset like a government bond is, in Keynes’s words, “the measure of the degree of our disquietude.”
“Our desire to hold money is a barometer of our distrust of … the future…. The possession of money lulls our disquietude, and the premium which we require to make us part with money is the measure of the degree of our disquietude.” – John Maynard Keynes
Another core issue you can connect to this story is the difference between the “Yes – Markets Self-Adjust” and No – Markets Fail Often” camps around the story of value function of money (Macroeconomics for Life, Ch 9.1)