ECB Announces Negative Interest Rates: Bitcoin Price Rallies

June 5, 2014
European Central Bank

In a landmark monetary policy move, the European Central Bank (ECB) has announced negative interest rates. The ECB will charge an interest rate of -0.1% to banks wishing to store euros within central bank vaults. Domestically, the intention is to prod banks into lending money to businesses as opposed to buying government bonds. Internationally, the intention is to cause depreciation of the Euro relative to other currencies to increase the competitiveness of European exporters. It is unlikely that individual users in the 18 countries under the ECB’s control will see negative interest rates on their savings accounts. It is more likely that banks will swallow the cost (-0.1%) and continue to offer zero-interest bearing accounts as has increasingly become the norm around the world now. However, Europeans will still have an effective negative interest rate on their bank holdings due to the leveraging of bank fees combined with zero-interest bearing accounts. The term ‘savings account’ has turned into somewhat of an oxymoron.


Negative Interest Rates

[dropcap size=small]C[/dropcap]entral banks around the world have tread the long sliding path to negative interest rates for the last few decades. In May, ECB President Mario Draghi brought the Euro area interest rate down to 0.5%, and many suspected that negative interest rates were coming. In the history of fiat currencies, only the Nationalbanken of Denmark had previously instituted negative interest rates back in 2012. It is important to note that Denmark’s economy didn’t move drastically in either direction as a result, contrary to the jeers of opposing economists from Keynesian and Austrian camps. Notably, the American central bank and the English central bank have both long avoided making such a drastic move. Even the Keynesians fear the reality of near zero interest rates, something that is referred to as a liquidity trap. Whether you believe in the power of liquidity preference or time preference, the ECB’s move tells us something about the current state of the world economy.

Real Interest Rates

The Fisher equation allows economists to estimate the real interest rate when the nominal interest rate and the inflation rates are known.

Where r is the real interest rate, i is the nominal interest rate, and π is the inflation rate.

Luckily (or unluckily depending on who you ask), large central banks such as the ECB have very clear inflation targets. Currently, the ECB’s inflation target is 1.1%. Even prior to the most recent ECB announcement, Europe had a negative real interest rate. The real interest rate is the real  rate that you will get when lending your money because it accounts for government created inflation in the monetary supply. They’ll tell you that inflation in the monetary supply is supposed to counteract inflation in the price level. The United States has an inflation target of 2% since 2012.

Results Of ECB Announcement

As has been previously stated, depreciation of the Euro versus other stores of value was to be expected. In the immediate aftermath of the ECB’ announcement the price of gold jumped 1% and the price of Bitcoin jumped 2%. Both markets have since corrected slightly; however, the signs are particularly clear. Negative interest rates are a sign of weakness in the established monetary regimes, plain and simple. Europeans have been hearing about the benefits of Bitcoin since early 2013 when depositors in Cyprus were involuntarily brought to the barbershop and forced to line up for a haircut. Cypriot savers have since filed suit against the ECB for their actions. There’s no doubt in my mind that more and more individuals within the Eurozone are realizing that Bitcoin represents freedom from the ECB.

Bitcoin price jumps 2% on ECB announcement of negative interest rates.

Picture from Business Insider

Last modified (UTC): June 5, 2014 17:05

Caleb Chen @bitxbitxbitcoin

Caleb is a graduate of the University of Virginia where he studied Economics, East Asian Studies, and Mathematics. He is currently pursuing his MSc in Digital Currency at the University of Nicosia.