The Signalling Channel of Negative Interest Rates

56 Pages Posted: 14 Jan 2020

See all articles by Oliver de Groot

Oliver de Groot

University of Liverpool Management School

Alexander Haas

University of Oxford - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 2020

Abstract

Negative interest rates are a new (and controversial) monetary policy tool. This paper studies a novel signalling channel and asks whether negative rates can be 1) an effective and 2) an optimal policy tool. 1) We build a financial-friction new-Keynesian model in which monetary policy can set a negative reserve rate, but deposit rates are constrained by zero. All else equal, a negative rate contracts bank net worth and increases credit spreads (the costly "interest margin" channel). However, it also signals lower future deposit rates, even with current deposit rates constrained, boosting aggregate demand and net worth. Quantitatively, we find the signalling channel dominates, but the effectiveness of negative rates depends crucially on three factors: i) degree of policy inertia, ii) level of reserves, iii) zero lower bound duration. 2) In a simplied model we prove two necessary conditions for the optimality of negative rates: i) time-consistent policy setting, ii) preference for policy smoothing.

Keywords: forward guidance, liquidity trap, monetary policy, Taylor rule

JEL Classification: E44, E52, E61

Suggested Citation

de Groot, Oliver and Haas, Alexander, The Signalling Channel of Negative Interest Rates (January 2020). CEPR Discussion Paper No. DP14268, Available at SSRN: https://ssrn.com/abstract=3518609

Oliver De Groot (Contact Author)

University of Liverpool Management School ( email )

Alexander Haas

University of Oxford - Department of Economics ( email )

10 Manor Rd
Oxford, OX1 3UQ
United Kingdom

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