Negative Interest Rate Policy: Implications for Monetary Transmission and Financial Stability

To revive the European economy and to ensure price stability over the medium term, the European Central Bank (ECB) started a negative interest rate policy (NIRP) in June 2014. In a SAFE Policy Lecture on 24 October 2016, Andreas (Andy) Jobst, Adviser to the Managing Director and the CFO of the World Bank Group, assessed the effectiveness of this much-discussed policy measure.

Jobst started his lecture by providing empirical evidence that the NIRP was a necessary step of the ECB (and other central banks) which has contributed to a modest credit expansion and easier financial conditions in Europe by effectively transmitting the marginal policy rate to money markets. Furthermore, Jobst pointed out that the apparent lack of cash hoarding implies that short-term nominal rates are still above the (negative) lower bound and that the zero lower bound has turned out to be less binding than expected by many economists.

Despite the positive effects for aggregated demand, the NIRP also comes at a cost however because it decreases bank profitability by reducing lending margins. Reduced lending margins arise because loans reprice quicker than “sticky” deposits – a factor that is particular prominent in countries such as Spain and Italy. According to Jobst, the banks have so far been able to mitigate the squeeze on profitability due to improved lending conditions, but future lending growth might be insufficient to offset the negative effects in the medium term.

To assess this difficult tradeoff theoretically, Andreas Jobst further presented a DSGE-model with sticky deposit rates. By simulating different scenarios of monetary transmission and stickiness of deposits, he draws the conclusion that NIRP has a positive aggregated impact in all scenarios. However, in the short-run, “sticky” deposits may weaken the positive effects by either decreasing bank profitability or reducing monetary transmission.