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The impact of setting negative policy rates on banking flows and exchange rates

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  • Khayat, Guillaume A.

Abstract

In the aftermath of the great contraction of 2008, policymakers were faced with the Zero Lower Bound (ZLB) on nominal interest rates. Central banks implemented several unconventional monetary policies to overcome the ZLB, including setting negative nominal interest rates. This paper explores possible unintended effects of setting negative policy rates. Using Danish data, I assess the impact of paying a negative interest rate on reserves. Results suggest that going into negative territory has a particular impact, distinct from that of simply lowering interest rates: it leads to higher banking outflows and depreciation of the currency. Due to the reluctance of commercial banks to pass on negative rates to their depositors (retail deposits can easily be switched into cash), paying a negative (vs. positive) interest rate on reserves creates a disconnection between the assets and liabilities of commercial banks' balance sheets. Commercial banks can avoid this disconnection by holding external assets or assets in foreign currencies. This incentive to increase banking outflows appears to explain the particular impact of going into negative territory.

Suggested Citation

  • Khayat, Guillaume A., 2018. "The impact of setting negative policy rates on banking flows and exchange rates," Economic Modelling, Elsevier, vol. 68(C), pages 1-10.
    • Handle: RePEc:eee:ecmode:v:68:y:2018:i:c:p:1-10
    DOI: 10.1016/j.econmod.2017.03.009
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    2. Romina Ruprecht, 2020. "Negative interest rates, capital flows and exchange rates," ECON - Working Papers 351, Department of Economics - University of Zurich.
    3. Grahame Johnson & Sharon Kozicki & Romanos Priftis & Lena Suchanek & Jonathan Witmer & Jing Yang, 2020. "Implementation and Effectiveness of Extended Monetary Policy Tools: Lessons from the Literature," Discussion Papers 2020-16, Bank of Canada.
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    5. Cynthia Balloch & Yann Koby & Mauricio Ulate, 2022. "Making Sense of Negative Nominal Interest Rates," Working Paper Series 2022-12, Federal Reserve Bank of San Francisco.

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    More about this item

    Keywords

    Monetary policy; Negative nominal rates; Unconventional monetary policies; Exchange rates; Banking flows; Markov switching;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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