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

Guillaume Khayat
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Guillaume Khayat: GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique

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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.

Date: 2018-01
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Citations: View citations in EconPapers (5)

Published in Economic Modelling, 2018, 68, pp.1-10. ⟨10.1016/j.econmod.2017.03.009⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02084889

DOI: 10.1016/j.econmod.2017.03.009

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