I understand conceptually what negative interest rates set by a central bank means for bond investing, but how does it impact equities in the short and long term? Would it just set off a short term spending boom followed by long term stagnant, as in Japan?
| +122 | Best SM seats in 2024? | 85 | 48m | |
| +93 | If and when to move to a pod? | 28 | 21h | |
| +73 | Pod Shop Regret | 24 | 3d | |
| +34 | Intellectual Caliber of People in HF | 37 | 3s | |
| +25 | Alta Fox - How did Connor Haley do it? | 20 | 47m | |
| +23 | Understanding pod shop leverage & cash usage | 2 | 4d | |
| +18 | UPenn SEAS vs Cornell Engineering | 8 | 4h | |
| +16 | SM Career Trajectory | 5 | 1d | |
| +15 | PMs: move across platforms, latest terms | 15 | 1d | |
| +10 | RIP Jim Simons | 15 | 31m |
Career Resources
Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
Hi Prospect in ER, just trying to help:
More suggestions...
You're welcome.
Bump
You need to specify an "...if all else is equal" clause, because the reason interest rates are negative is that the bank is trying to combat certain other things have gone wrong with the economy, and those other factors will be much more important for equity investing than the interest rates themselves. So the real question isn't what are the effects of negative interest rates, but what are the effects of those other factors -- negative interest rates are the symptom, not the disease. And it's weird to talk about "the long term" effects of negative interest rates, because they're supposed to be a short term thing -- if they become semi-permanent, then your economy is truly broken.
But theoretically, negative interest rates will push everyone out of bonds, and the money has to go somewhere, so it should lead to an investment boom in equities and real estate. Theoretically, all that money will drive down returns in those spaces, too; but the bank is hoping all that investment will create new jobs and new long-term industries. At some point, the bank should rise rates again and you reach equilibrium.
Of course, there's all kinds of other political factors, like for instance if you have a massive national debt that you're paying interest on. You can afford to pay interest on your treasuries at near-zero interest rates, but when the rate starts to climb back up to 5% that eats up a lot of your government spending, so there's political pressure to keep rates low forever.
Good 'ole Ceteris Paribus...
This is why I love economics. You laid out a great explanation of how it all interacts instead of a singular ledger or other specific measures. My understanding was for instance the ECB went to NIRP for that very idea of pushing money into equities, spending, and other asset purchases versus just letting all those Euros sit in the bank so they could stimulate and prod the economy back to life. The flipside is that a lot of the contrarians more or less took their balances out in cash and parked it under the matress. So that money was taken out of circulation out of fear and won't be used for the ECB's intended effect.
OP, speaking of economics; Japan also faces another interesting tangle in their ongoing story. They're below stable repopulation rate, let alone any kind of growth rate, and they have a very sizeable eldery population that requires care/penion benefits along with a bevy of other social programs that need significant funding because to their credit they don't mess around. So what do you do? Issue debt like it's going out of style and have your central bank buy it up of course! They're at the point where they're buying up debt at such a pace that there'll be no JGB left for them to buy in 33 weeks. For perspective, we get sour faced about having trillions in debt here in the US. Japan has QUADRILLIONS in debt. Ok, yeah, after the exchange rate it equals out a bit. But the latest chapter of their ongoing saga is that the Yen's value had sagged so hard because of all those underlying factors, the BOJ had to announce they're actively intervening to try and mediate exchange rates. Which of course, will feed back into the bond markets and makes that quadrillions to trillions comparison flow back towards the edgy side.
Thanks for the detailed explanation! I'm curious, what are the contrarians so afraid of that they would rather hide their cash under a mattress and suffer the full brunt of inflation rather than invest it in European stocks or foreign bonds/stocks/real estate etc if European investments provide too low of a yield?
Also, do you see a light at the end of the tunnel for Japan regarding this crisis?
I appreciate the detailed answer and I apologize to you and my high school econ teach for not using ceteris paribus. Regarding what I meant in terms of long term effects, I was curious about how the chronic negative (or near zero) rates in European countries affected their economy.
Another poster talked about how these negative rates caused the contrarians to stash money away instead of investing, but how would long-term use of negative rates, all things being equal, affect the business and investment landscape of a country in the long run? I assume as investment yields shrink in the home country, the nation's investors will move their money into investments in other countries, leading to capital flight and anemic future growth for the home country?
Well, the *real* answer is that there's laws that force you to accept the negative interest rate. Lots of countries require banks to hold deposits in treasury bonds, so you're forced to buy them even if the rate is negative, for instance. And many countries have capital controls (either official laws or just unofficial disapproval from the regulators) preventing you from taking your capital out of the country.
Negative interest rates violates the fundamental economic laws of time-value of money, but that's the point -- they would never appear naturally in a free market and they exist only when a government is intervening to artificially coerce investors towards certain types of investment. The government made the rates negative for a reason. If you're moving capital abroad to circumvent that reason, then the government will block you. If the government wants to keep interest rates negative for a long time, they can do it and the economy will either survive or not based on the totality of government policy. So don't even bother thinking about the theoretical long-term effects of negative interest rates, because it's entirely dependent on the government policy that manages the rates.
Omnis totam ullam unde totam. Quia delectus ad eos delectus necessitatibus ut. Reiciendis nesciunt ipsa vel voluptatem quia.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...