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Here's why the Fed chair keeps getting drilled on negative interest rates

What does NIRP look like?

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Despite so much talk about rising interest rates, a whole new idea is making its way around Washington D.C. that would reverse the projected course of the Federal Reserve.

It was less than two months ago that the Fed announced it was officially raising the federal funds rate for the first time since June 2006.

Now Fed Chair Janet Yellen is being asked about the possibility of a Negative Interest Rate Policy, as an option to the Zero Interest Rate Policy from the last several years we've all come to know.

Yellen’s hearing before the House Financial Services Committee Wednesday morning focused heavily on the feasibility of NIRP.

When asked about a Negative Interest Rate Policy in the semi-annual monetary policy hearing, Yellen said that is something that should be examined by the Federal Reserve.

“In the spirit of prudent planning, in light of European experience, we will look at, we should look at. It isn’t just a question of legal authority, it’s also a question of could the plumbing of the payments system in the United States handle it? Is our institutional structure of our money markets compatible with it? We have not determined that,” said Yellen.

While the idea of an investor agreeing to pay a borrower to take their money may sound like ludicrous, an article in Quartz by explained that the idea isn’t a “sucker’s bet after all.”

From Quartz:

On the face of it, paying someone to borrow your money seems like a bad idea. But it isn’t, necessarily. Why? Deflation.

Generally speaking, interest rates on bonds are fixed. (That’s why bonds are called “fixed income” instruments.) For the most part, they don’t account for changes in prices. So an investor who is expecting prices to decline can buy a bond with a negative interest rate, and still expect to make a return in “real,” that is price-adjusted, terms.

The U.S. wouldn’t be the first to venture into this, with the Quartz article referencing central banks in the Eurozone (Sweden, Switzerland, and Denmark) all having pushed their benchmark short-term interest rates into negative territory.

But not everyone is sold on the idea of a NIRP.

An article in CNBC by Jeff Cox states:

"Things would have to get truly desperate to go to negative rates," Kim Rupert, managing director of global fixed income at Action Economics, said in an interview. "Our money markets are obviously the biggest in the world and have a lot of commitments tied to them and the liquidity for a lot of our economy. Jeopardizing the money markets would be too dramatic an effect for the Fed to consider going in that direction."

Still, the futures market is indicating that if the Fed doesn't move to outright NIRP, the chances for an aggressive rate-hiking policy ahead, as indicated after the December rate rise, are nil.

On Thursday morning, Yellen addressed the Senate Banking Committee for the second day of her testimony on monetary policy, where she was once again asked about NIRP.

An article in MarketWatch said Yellen reiterated that she did not want to take negative rates off the table as a policy tool. However, not every Senator was on board with the idea.

From the article:

Sen. Patrick Toomey, R-Penn., tries to dissuade Yellen from adopting negative rates.

Negative rates haven’t helped the economies where they are now in place, Toomey said, adding the end result would just be to put the U.S. in the midst of an ongoing global currency war.

Negative rates would also just be a tax on savings, he concludes.

Yellen replies she found it surprising that other central banks have been able to cut rates so far into negative territory, and said small depositors haven’t been affected.

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