Working Paper: CEPR ID: DP14268
Authors: Oliver de Groot; Alexander Haas
Abstract: Negative interest rates remain a controversial policy for central banks. We study a novel signalling channel and ask under what conditions negative rates should exist in an optimal policymaker’s toolkit. We prove two necessary conditions for the optimality of negative rates: a time-consistent policy setting and a preference for policy smoothing. These conditions allow negative rates to signal policy easing, even withdeposit rates constrained at zero. In an estimated model, the signalling channel dominates the costly interest margin channel. However, the effectiveness of negative rates depends sensitively on the degree of policy inertia, level of reserves, and ZLB duration.
Keywords: monetary policy; Taylor rule; forward guidance; liquidity trap
JEL Codes: E44; E52; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative interest rates (E43) | future policy easing (E52) |
| discretionary policy setting (E60) | use of negative interest rates (E43) |
| preference for smoothing policy (C54) | use of negative interest rates (E43) |
| negative interest rates (E43) | lower expected future deposit rates (E43) |
| contractionary impact of negative interest rates (E43) | expansionary intertemporal aggregate demand effect (E00) |
| degree of policy inertia (D78) | effectiveness of negative rates (E43) |
| level of reserves (Q30) | effectiveness of negative rates (E43) |
| duration of the zero lower bound (ZLB) (E43) | effectiveness of negative rates (E43) |