Wednesday, 9 September 2020

Zero Interest Rates

Firstly, what is a zero rate?

Zero Rates, Forward Rates, and Zero-Coupon Yield Curves. The n-year zero-coupon interest rate is the rate of interest earned on an investment that starts today and lasts for 'n' years. All the interest and principal is realized at the end of 'n' years.

Despite low returns, near-zero interest rates lower the cost of borrowing, which can help spur spending on business capital, investments and household expenditures. Businesses' increased capital spending can then create jobs and consumption opportunities. However, the markets are having a really tough time with this state and it should not contiue.

If the main players [Bank of England, Federal Reserve, World Bank] nudge rates to zero, they have few options left. The goal of below-zero rates would be to spur other banks to lend more, jolting a sluggish economy, and encourage consumers and businesses to spend rather than save their money. Interest rates are established by central banks and flow down to commercial banks and other financial institutions. With negative interest rates, account holders get charged a nominal rate instead, so they lose money by keeping it in the bank.

There is the possibility that free banking will end for the consumer and we will see a return to current accounts that have fees or charges attached to them.

Prime money-market funds, a long-time favorite for anyone seeking a cash-like investment with a little extra yield, are facing an existential challenge, just four years after a regulatory overhaul to restore confidence in the wake of the global financial crisis. Assets in these vehicles dropped 20% in just six weeks earlier this year, spurring talk of new reforms. But some of the industry’s leaders are opting for another solution: Shutting them down.

As the pandemic crushed economic activity and wracked global markets in March, prime fund investors moved money as fast as they could into government money-market funds, considered the safest of havens because they are limited to short-term government securities and related secured lending markets. Prime funds lost more than $150 billion of assets to withdrawals between late February and early April; as a cash-like product with credit exposure, these funds are uniquely vulnerable to runs in a crisis.

Zero rates should not be a goal and interest rates should start to rise again before an even bigger problem is caused.

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