Negative Interest Rates: Rewarding Profligacy

by L. Dwayne Barney and Paul A. Cleveland

Presently there are trillions of dollars of bonds throughout the world with negative interest rates. This is an unprecedented turn of events, and one that has many nonprofessional investors confused. Savers are understandably puzzled as to how it is possible for bonds to carry negative interest rates. After all, would an intelligent person really lend $1,000 to someone only to be paid back $950 one year from now?

Economists historically have taken it as a given that people prefer current consumption over the promise of an equivalent amount of consumption at some specified date in the distant future. If you ask anyone whether they would like $1,000 today or $1,000 in ten years, or even in a year, the choice is uniformly for the immediate cash. The future is uncertain, and the preference is always for the immediate reward. Indeed, this preference for current over future consumption is why interest rates exist: people need to be compensated for postponing consumption to a future point in time.

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