econ 4325 monetary policy lecture 12: negative interest rates · putting it all together negative...

ECON 4325Monetary policy

Lecture 12: Negative interest rates

Ragnar E. Juelsrud

April 26th, 2018

Zero Lower Bound (may be) here to stay

Zero Lower Bound ⇔ interest rates at zero

Kiley & Roberts (2017) - Interest rates at zero approx. 30 percent oftime going forward

Central bankers need other tools to fight next recession

Forward guidanceQuantitative + credit easingNegative nominal interest rates

Juelsrud ECON4325 April 26th, 2018 1 / 26

Negative interest rates are prevalent

-2

0

2

4

6Po

licy

rate

1/1/2008 1/1/2010 1/1/2012 1/1/2014 1/1/2016 1/1/2018

SwedenSwitzerlandJapanECBDenmark


What is the rationale?

Negative rates ⇒ ”pretend” like ZLB does not exist

Makes sense in the standard NKM

πt = βEt [πt+1] + κyt

yt = Et [yt+1]− 1

σ

(iCBt − Et [πt+1]− rnt

)iCBt = ρ+ φππt + φy yt

iCBt ↓ ⇒ yt ↑, irrespective of whether iCBt ≷ 0


Negative rates are controversial

... Cutting the repo rate below zero ... is expected to have similar effectsto repo-rate cuts when the repo rate is positive, as all channels in thetransmission mechanism can be expected to be active. Riksbanken, 2015

The MPC is very clear that ”lower bound” is a positive number ... I amnot a fan of negative rates. We see the negative consequences through thefinancial system in other jurisdictions ... M. Carney (BoE), August 2016

... the room to cut rates that are below zero is limited. Norges Bank,MPR 1/16


What is special about negative interest rates?

In theory: Households face iCBt

In reality: iCBt affects other interest rates in the economy that arerelevant to households and firms (deposit and lending rates)


yt = Et [yt+1]− 1

σ(it − Et [πt+1]− rnt )

iCBt = ρ+ φππt + φy yt

it = f(iCBt

)f(iCBt

)can be microfounded by adding a banking sector, see for

instance Curdia & Woodford (2010)

f(iCBt

)is crucial for whether negative rates work or not


Different views on pass-through

it

iCBt


Worries about limited pass-through

Worry that pass-through of negative policy rates to deposit rates willbe weaker

Standard ZLB-logicMoney act as a store of value ⇒ Households guarantueed a return ofzeroBanks are reluctant to impose negative interest rates on depositors


How big is this of a concern?

0 20 40 60 80 100

Fraction of respondents that would withdraw money from savings account (%)

AS

LU

NL

CZ

PO

DE

TU

ES

BE

RO

US

AU

FR

UK

IT

Figure: Survey results. Source: Eggertsson et.al (2017)


Model with ZLB on deposit rates


yt = Et [yt+1]− 1

σ

(max{0, iCBt } − Et [πt+1]− rnt

)iCBt = ρ+ φππt + φy yt

If iCBt = 0, further interest rate cuts have no effect

This is equivalent to the ”standard” ZLB!

If the deposit rate represent the marginal cost of funds for banks,losing influence over the deposit rate reduces influence of the lendingrate


What we need to know

A lot of research in this area these days

Current research focuses on the pass-through of negative policy ratesto banks lending and deposit activities

Some preliminary evidence

Eggertsson et.al (2017) provides overview of experiences with negativerates and implement negative interest rate into the NKMHeider et.al (2018) focus on Euro AreaBasten & Mariathasan (2018) focus on Switzerland

Remainder of this lecture: summarize what we know so far about thepass-through of negative rates


Fact 1: Deposit rates are bounded

02

46

Perc

ent

2008 2010 2012 2014 2016 2018

Corporations HouseholdsPolicy rate

Sweden

Figure: Deposit rates, Sweden. Source: Eggertsson et.al (2017)

Similar picture for Denmark, Japan and Switzerland


But some countries have not reached the bound

01

23

45

Perc

ent

2008 2010 2012 2014 2016 2018


Euro Area

Figure: Deposit rates, Euro Area. Source: Eggertsson et.al (2017)


Fact 2: Lending rates appear less responsive as well

02

46

8Pe

rcen

t

2008 2010 2012 2014 2016 2018


Sweden

Figure: Lending rates, Sweden. Source: Eggertsson et.al (2017)


Fact 2: But less so when deposit rates continue falling

02

46

Perc

ent

2008 2010 2012 2014 2016 2018


Euro Area

Figure: Lending rates, Euro area. Source: Eggertsson et.al (2017)


Fact 2: Lending rates appear less responsive as well cont.

010

2030

40R

elat

ive

chan

ge in

dep

osit

rate

22.

53

3.5

4Le

ndin

g R

ate

Repo: 0.75 0.25 0 -0.1 -0.25 -0.35 -0.50

Bank rates Pass-Through Deposit Rate

Swedish Bank Lending Rates

Figure: Bank-level lending rates, Sweden. Source: Eggertsson et.al (2017)


Drop in median correlation and increase in dispersion

-.5

0

.5

1C

orre

latio

n w

ith re

po ra

te

Positive ratesNegative ratesNegative rates (bound)


Fact 3: Weaker correlation for banks with high depositshares

-1.78 (0.45) ***

-1

-.5

0

.5

1C

orre

latio

n w

ith re

po ra

te

.2 .4 .6 .8 1

Deposit share

Figure: Repo and bank rate correlation, Sweden. Source: Eggertsson et.al (2017)


Lower lending growth

∆ log (Lending)i ,t = α + β(I postt × Deposit sharei

)+ δi + δt + εit

Figure: Lending growth, after implementation of negative rates in Sweden.Source: Eggertsson et.al (2017)


Taking stock

The experiences with negative interest rates so far are mixed

When bank interest rates already are low ...

⇒ decoupling from policy rate⇒ monetary policy less effective

In fact, negative interest rates can be harmful

”Negative rates starting to weigh on banks profits” (Financial Times18th of August, 2016)


A reminder on how banks work

Banks make money by having higher interest rates on their assetsrelative to their liabilities

Negative rates on reserves ⇒ lower profits

Because CB control reserve supply, banks in aggregate have netreserves


Can banks avoid negative rates?

What can banks do to avoid negative rates?

Answer: Withdraw all reserves into cash.

HUGE costs

FT: European reserves in cash (largest bill possible) would fill 195hotel rooms ...


Negative interest rates harm bank equity

With asymmetric information, banks face a balance-sheet constraint

P ≥ ηDη is constraintP is market value of equityD is total debt the banks take on (i.e. reserves + bonds + loans)

P = Expected future profits of holding bank stock


Negative interest rates harm bank equity, cont’d

Assume only 1 period

Profits = i lL + i rR − idD

i l interest rate on loans Li r interest rate on reserves Rid interest rate on deposits D

With negative interest rates, i r < 0 and id ≈ 0

Profit ≈ i lL + i rR

i r ↓ ⇒ Profit ↓ ⇒ market value of equity ↓ ⇒ balance sheetconstraint tightened


Empirical evidence

Ampudia & Van den Heuvel (2017): Looks at what happens to bankequity values with positive and negative rates

FindingsPolicy rate reduction in positive territory ⇒ bank equity increases invalue (”bank capital channel”)Policy rate reduction in negative territory ⇒ bank equity decreases invalue ⇒ Collateral constraint tightens


In theory

Figure: Impulse responses from discount rate shock. Source: Eggertsson et.al(2018)


Putting it all together

Negative nominal interest rates are a new, radical policy experiment

Just starting to gain evidence on how effective it is

So far, it seems like1 Deposit rates remain stuck at zero (no pass-through to deposit rates)2 Once deposit rate become stuck, limited pass-through to lending rates3 Evidence that bank balance sheets are weakened

Bank lending channel substantially weakened (but other channels maystill be active)

On the upside: Less cash in society ⇒ ZLB-problems less severe ⇒negative rates potentially more expansionary


econ 4325 monetary policy lecture 12: negative interest rates · putting it all together negative...

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