Although the experience with negative nominal interest rates is limited, we tentatively conclude that overall, they help deliver additional monetary stimulus and easier financial conditions, which support demand and price stability. ..IMFdirect

Posted on April 10, 2016 by iMFdirect

The Broader View: The Positive Effects of Negative Nominal Interest Rates

By Jose Viñals, Simon Gray, and Kelly Eckhold

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We support the introduction of negative policy rates by some central banks given the significant risks we see to the outlook for growth and inflation. Such bold policy action is unprecedented, and its effects over time will vary among countries. There have been negative real rates in a number of countries over time; it is negative nominal rates that are new. Our analysis takes a broad view of recent events to examine what is new, country experiences so far, the effectiveness of negative nominal rates as well as their limits and their unintended consequences. Although the experience with negative nominal interest rates is limited, we tentatively conclude that overall, they help deliver additional monetary stimulus and easier financial conditions, which support demand and price stability. Still, there are limits on how far and for how long negative policy rates can go.

Why are central banks using negative policy rates?

Once policy rates are cut to what used to be known as the ‘zero lower bound’, central banks can employ unconventional monetary policy measures to provide further stimulus if real interest rates are still above the levels consistent with price stability and full employment. Negative nominal policy interest rates are the latest addition to this unconventional toolkit. Six central banks so far have introduced negative rates that apply to some amount of the cash balances commercial banks hold with the central bank (Table 1). Negative rates aim to encourage the private sector to spend more and support price stability by further easing monetary and financial conditions. For smaller open economies, negative rates can also help discourage capital inflows and reduce exchange rate appreciation pressures.

There are synergies between negative policy interest rates and quantitative easing. Negative policy rates have thus far been associated with expanded central bank balance sheets as a result of quantitative easing or large-scale foreign exchange purchases. Quantitative easing compresses yields and term premia, though it has some limits since over time it reduces the availability of assets for further purchases by the central bank. Moving policy rates negative aims to lower money market rates and push down the yield curve further, and boost portfolio substitution effects, thereby increasing the potency of monetary policy. In fact, negative deposit rates tend to have more bite when a large amount of commercial banks’ reserves are priced at the negative rate.

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