Negative interest rates

Date posted: November 30, 2010

Normally we think of interest rates being a positive number. That is, if we borrow some money, we have to pay some interest rate on the loan — meaning we’ll pay back more than we borrowed. Or if we invest, we expect to earn money — that is, interest on my funds. But a new investment recently offered a negative interest rate. N.C. Cooperative Extension economist Mike Walden explains.

“This was a first. This was with an investment called a TIPS, or Treasury Inflation Protected Security. It is an investment that has been around a long time, and we actually recently saw that rather than an investor who invested money in TIPS say they would actually get paid by the government an interest rate at some future time, the investor said, ‘We will pay you. We’ll pay you — the government — to allow us to invest in this TIPS.’ And in fact the interest rate paid was 0.5 percent. And what that means is when you cashed in the TIPS down the road, you would actually get less money back than you put in — which is, of course, actually opposite the way a traditional investment works.

“And I think two things are going on here. One is TIPS are considered very, very safe investments — almost rock solid safe. So I think it reflects the continuing fear by many investors about investments, and they are actually willing to pay for safety — willing to pay to have their money locked up safely, if you will. And of course, these TIPS or treasury securities do offer that. But secondly the way TIPS works is that they are going to account for how much inflation occurs in the future. And so even though if that investor paid to initially invest in the TIPS, if we have inflation down the road they’re going to get that back also, which would actually turn the investment into a positive thing for the investor. That is, they would make money on that investment.

“So I think the second thing that is going on here is we are beginning to see investors expect more inflation down the road, which fits in exactly with what the Federal Reserve right now wants to happen.”

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