Learn with ETMarkets: What is negative interest rate

KOLKATA: The US Federal Reserve seems to be in line to raise interest rates again after last December's rise, as the sustained low interest regime and higher government spending failed to lift the economy.

The quantitative easing had limited impact on economic revival amid a near-zero interest rate. John Maynard Keynes described this situation as liquidity trap where cash infusion in the system fails to lower interest rates and does not bear the desired impact on the economy. The negative interest rate policy adopted by Japan and some European countries in the last decades has failed, too.

What is a liquidity trap?
A scenario in which expan sionary monetary policy via cash infu sion in the banking system fails to lower in terest rates, making monetary policy ineffec tive. The situation was first described by John Maynard Keynes.

What is a negative interest rate?
When interest rate goes lower than zero. If a bank keeps its interest negative, the depositors need to pay regularly to keep their money with the bank instead of earning return on deposits. Investors tend to hoard cash in such a sit uation instead of park ing it with banks.

Why do central banks keep interest rates negative?
Banks worldwide keep excess reserves with central banks.

Keeping interest rates negative is a typical central bank strategy to push banks to buy alternate assets or explore profitable lending opportunities, instead of keeping the money idle with central bank.

Why there are prolong negative interest rates?
After the global financial crisis, money market interest rates re mained very low, prompting many commercial banks to hold higher balances with central banks. Negative interest rate was to discourage banks from holding excess reserves.

Is the thinking changing?
Several economists argue that keeping interest rates very low or negative has delayed the global economic recovery . Outgoing Reserve Bank of India Governor Raghuram Rajan has several times raised concerns over the availability of easy money across developed economies, which has led to deflation and seems to have backfired as a policy to propel growth.

Now, Fed chair Janet Yellen has hinted the possibility of raising US short-term rates. If the US raises rates, the UK will come under pressure, too. The UK's central bank, Bank of England, had earlier in the month cut interest rate to 0.25% to provide fillip to the struggling economy , but many are apprehensive about its impact.