On the Negatives of Negative Interest Rates and the Positives of Exemption Thresholds
University of Zurich, Department of Economics, Working Paper No. 372, December 2020
61 Pages Posted: 13 Jan 2021
Date Written: December 16, 2020
Abstract
Major central banks remunerate reserves at negative interest rates and it is increasingly likely that they will keep rates negative for many more years. To study the long run implications of negative rates, we construct a dynamic general equilibrium model with commercial banks funding investment projects and a central bank issuing reserves. Negative rates distort investment decisions resulting in lower output and welfare. These findings sharply contrast the short-run expansionary effects ascribed to negative rate policies by most of the existing literature. Negative rates also reduce commercial bank profitability. Exempting a fraction of reserves from negative rates can resolve profitability concerns without affecting the central bank's ability to control the money market rate. However, exemption thresholds do no mitigate the investment distortions created by negative rates.
Keywords: Negative interest rate, money market, monetary policy, interest rates
JEL Classification: E40, E42, E43, E50, E58
Suggested Citation: Suggested Citation