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Can Central Banks Spur Inflation with Negative Interest Rates?

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Market uncertainty diverts funds to sovereigns for safety

When demand conditions are low and Market uncertainty creeps in, investor funds tend to flow toward sovereign bonds for safety. Even at zero-bound rates, the negligible credit risk aspect tends to keep investors’ money off the Markets and into sovereign bonds (GOVT). This negatively impacts economic growth. Investments spur demand and productivity, which in turn fuel inflation and growth.

“Credit and electronic money has its modern day disadvantages in that you can’t withdraw billions of physical Euro Notes from the local bank, nor can banks withdraw some from the central bank,” explained Bill Gross in his April 2016 Investment Outlook published by Janus Capital (JNS).

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Can negative rates kick-start an economy’s inflation and growth?

By introducing negative interest rates, the central bank’s intention is to force investors to buy something with a positive yield. When more and more investors start putting their money in Market investments and other assets, overall demand and economic activity gets some heat.

Japan (EWJ), Sweden, Denmark, and Switzerland have already introduced negative interest rates. The Eurozone (EZU) is at 0%, while the United States (IWM) and the United Kingdom (EWU) are at 0.50% each.

However, a huge side-effect to this approach of spurring growth and inflation is seen in the breakdown of capitalistic models, which we’ll discuss next.

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