"Negative impact"
Moreover, holding the official banking rates low for a long time has deflation impacts. As a banking rate stays low, requirement of internal rate of return on investment decisions starts declining. Theoretically, that leads banks to rend more, encourage innovation and entrepreneurship, and help economic recovery. In a practice, that encourage companies to stay in a segment where is no longer profitable, and other companies move into a business where is not profitable enough even on its proposal.
In a world where banking rate is zero, a company is willing and able to invest in a market where it can expect less than one percent return on equity. They tend to stay in existing businesses where they can expect at least minimum rate of return rather than challenging new markets where it is uncertainty. This conservatism cause cutthroat competitions and it drives the prices of goods down. This is the deflationary impact.
In the world of deflation, people postpone a purchase because they can buy it later for a better price. Low official banking rate discourages purchase itself and people’s willingness to shop and it encourage people to save more. Moreover, low interest rate itself leads people to save more.
Cutting official cash rate does not lead to cutting credit rates of individual customers, but it has effect on interest rates of their saving accounts. Their deposit interest rate declined faster than their credit rates (even if it does). If the interest rate has cut from 4% to 1%, the difference is only 3% annually. But the difference becomes almost 100% if you are saving up-to 20years for your retirement. In a form of 20years annuity, you have to save about 30% more annually to accumulate the same amount of retirement benefit that the 4% interest rate provides. The 3% change causes 30% difference in their annuity. This would lead people to save more for the future, rather than spend it now.
Moreover, holding the official banking rates low for a long time has deflation impacts. As a banking rate stays low, requirement of internal rate of return on investment decisions starts declining. Theoretically, that leads banks to rend more, encourage innovation and entrepreneurship, and help economic recovery. In a practice, that encourage companies to stay in a segment where is no longer profitable, and other companies move into a business where is not profitable enough even on its proposal.
In a world where banking rate is zero, a company is willing and able to invest in a market where it can expect less than one percent return on equity. They tend to stay in existing businesses where they can expect at least minimum rate of return rather than challenging new markets where it is uncertainty. This conservatism cause cutthroat competitions and it drives the prices of goods down. This is the deflationary impact.
In the world of deflation, people postpone a purchase because they can buy it later for a better price. Low official banking rate discourages purchase itself and people’s willingness to shop and it encourage people to save more. Moreover, low interest rate itself leads people to save more.
Cutting official cash rate does not lead to cutting credit rates of individual customers, but it has effect on interest rates of their saving accounts. Their deposit interest rate declined faster than their credit rates (even if it does). If the interest rate has cut from 4% to 1%, the difference is only 3% annually. But the difference becomes almost 100% if you are saving up-to 20years for your retirement. In a form of 20years annuity, you have to save about 30% more annually to accumulate the same amount of retirement benefit that the 4% interest rate provides. The 3% change causes 30% difference in their annuity. This would lead people to save more for the future, rather than spend it now.