Negative Rates and the Effective Lower Bound: Theory and Evidence

Michael McLeay, Silvana Tenreyro and Lukas von dem Berge

Journal of the European Economic Association, 2026, vol. 24, issue 1, 1-57

Abstract: With the monetary policy lower bound a re-emerging concern in some locations, we present new insights on the impact of negative policy rates. We develop a new theoretical model to match the empirical evidence on their effects. The model features a heterogeneous, oligopolistic banking sector where loan pricing is determined in part by the availability of deposit funding and in part by wholesale funding. The use of non-deposit funding ensures that the bank lending channel of negative rates remains active. We explore the impact of the policy on different types of banks: High-deposit banks may experience a fall in interest margins and profitability, which can result in reduced lending. But this is more than compensated for by greater lending from low-deposit banks. We embed this banking sector in an open-economy macroeconomic model, featuring exchange-rate and capital market transmission channels, which continue to work as normal when rates are negative. These non-bank channels, combined with general equilibrium effects and an active bank lending channel, mean that the transmission of negative rates is only somewhat weaker than the transmission of conventional policy.

Date: 2026
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