5. Bonds and interest rates Flashcards
“Is There a Zero Lower Bound?”
Explain what the corporate channel of monetary policy is and how it works?
- Negative rates increase the cost of holding cash – discourage the corporate savings
- Firms rebalance their assets and expand their investments – economic growth
- Firms who are associated with banks who charge negative rates and are more exposed to negative rates via higher liquidity, experience higher fixed asset growth (more investment) and a decrease in liquidity (they finance it with excess cash they had before)
- Stronger effect for smaller firms (they rely more on their relationship with banks for credit, so they can’t leave easily)
“Is There a Zero Lower Bound?”
Explain what the corporate channel of monetary policy is and how it works?
- Negative rates increase the cost of holding cash – discourage the corporate savings
- Firms rebalance their assets and expand their investments – economic growth
- Firms who are associated with banks who charge negative rates and are more exposed to negative rates via higher liquidity, experience higher fixed asset growth (more investment) and a decrease in liquidity (they finance it with excess cash they had before)
- Stronger effect for smaller firms (they rely more on their relationship with banks for credit, so they can’t leave easily)
“Is There a Zero Lower Bound?”
Why are investment-grade banks more effective in monetary policy implementation in a negative interest rate environment?
1) Corporate treasurers are advised to deposit liquidity in banks whose deposits have high ratings (if something happens, the money does not disappear-> linked to the safe asset idea)
2) Strong relationships with safe banks may be good insurance for firms in case their financing needs increase in the future.
3) Healthy banks are better able to transfer negative rates onto deposits
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What is the main conclusion of the article?
The positive effects of the NIRP on the economy are stronger if banks are healthy and can charge negative rates on deposits.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What are the findings on monetary policy transmission (effectiveness of the monetary policy depending on the current interest rate)?
- Above the ZLB, all banks pass on most of the policy interest rate cut to commercial deposits (MECHANISM WORKS);
- Around the ZLB, little pass through, even after a year only 20% of the original cut is reflected (MECHANISM IS WEAK – support for HARD ZLB);
- Below the ZLB, pass through increases but only for financially sound banks
(MECHANISM WORKS FOR SOUND BANKS; WEAK BANKS – MONETARY PASS-THROUGH IS NOT HAPPENING).
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What is the paper about?
The paper:
- examines how effective the monetary policy is in a low and negative interest rate environment
- describes how these effects are transferred unto the economy
- describes how banks and firms are affected by negative interest rate policies.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What is the reasoning behind the paper? Why is it needed now?
Recently (in the past decades) many economies have entered a low interest rate environment, with some even deploying negative interest rate policies.
The authors examine how it occurs, and what are the consequences.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
When does zero lower bound (ZLB) occur?
It occurs when interest rates are very low
=> rates cause liquidity trap
=> monetary policy is severely limited
=> and CB’s cannot stimulate demand by lowering r
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
How do negative interest rate policies (NIRP) work?
Negative rates reduce banks’ profits and lead them to reduce lending.
NIRP provides stimulus to the economy through firms’ asset rebalancing. Firms with high cash holdings linked to banks charging negative rates increase their investment and decrease their cash-holdings to avoid the costs associated with negative rates.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
How does NIRP reflect on sound banks?
- sound banks are more likely to charge negative rates once ECB does so
- banks do not experience a decrease in deposits even if they charge negative rates
=> for sound banks that tend to offer negative rates when ECB does as well, the deposits increase
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What is the main finding of this paper?
When banks are sound, the NIRP can effectively
stimulate the real economic activity by influencing the behavior of both banks and firms.
Explanation:
1) sound banks pass the negative rates on the corporate depositors
2) the transmission mechanism is enhanced by the fact that firms whose deposits are more exposed to negative rates decrease their liquid asset holdings and start investing more in fixed assets (both tangible and intangible)
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
What happens to firms that have relationships with banks that offer negative rates?
They are more exposed to negative rates if they hold a lot of cash. These firms lengthen the maturity of the assets to improve their profitability. Thus, they decrease their short-term assets and cash and increase their fixed investment.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
When does a zero lower bound (ZLB) arise?
How does it affect sound banks?
ZLB arises only if agents lack confidence in the banking system and deposits shrink when the interest rate approaches zero.
For sound banks, the transmission mechanism appears to be unaffected even when interest rates turn negative.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
Which banks are more likely to charge negative rates?
Banks in non-stressed countries are more likely to charge negative rates on corporate deposits.
“Is there a zero lower bound? The effects of negative policy rates on banks and firms”
How does the health of the bank impact the amount of pass-through?
Conventionally weaker banks used to pass most of the effect, as they could lend more.
