“Is there a zero lower bound? The effects of negative policy rates on banks and firms” Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton Flashcards
What is the main idea?
Investigates how the pass-through of monetary policy to interest rates on corporate deposits varies when the central bank moves into negative territory.
What is the recent interest rate trend?
Recently, many economies have entered a low interest rate environment (and then exited back), with some even imposing policies with negative interest rates.
What problems does low interest rate environment have?
● Macroeconomic problems (zero lower bound):
When the interest rates are low and the economy is in liquidity trap, banks cannot lower the deposit rate. If they do so, their clients will just start hoarding the paper money. However, this would severely affect banks because big part of their BS comprises of deposits.
● Negative interest rate policies:
Negative rates reduce banks’ profits and lead banks to reduce lending. However, negative rate policies still could work if there was particular mechanism to increase the costs of hoarding paper currency.
How does the monetary policy transmission work with negative interest rates?
Transmission mechanism is not weakened below ZLB, although it works differently:
o On average the pass-through from policy rates to deposit rates was significantly reduced when policy rates hovered on either side of the ZLB (zero lower bound), but pass-through increased again after the ECB moved further into negative territory
o Pass-through was lower than during positive rates
o All sound banks passed on most of policy interest rate cut in 12 months
Transmission mechanism is poor for less healthy banks
o Sound banks did not experience deposit outflows during NIRP
Due to high D for liquidity n safe assets
What is the impact of negative rates on firms?
● Negative rates increase the cost of holding cash, this discourages the corporate savings. Firms rebalance their assets and spend cash to expand their investments i.e. promote economic growth.
● The real effect of NIRP are associated with firms rebalancing their assets (Novel transmission policy):
Firms w high liquidity increase investment in tangible/intangible assets
Decrease liquid assets to avoid the costs of negative i rates
The effect is even stronger for smaller firms, as they highly rely on the relationship with bank for credit.
● Firms with high liquidity experience a small drop in profitability in the first year of negative rates, they increase investment and the investments start to pay off.
Before NIRP firms hoarded liquidity and applied too high discount rates to investment.
● Firm’s incentives to invest could be further strengthened by managers’ behavioural biases associated with the fact that negative rates force firms to pay to store liquidity.
What is the impact of negative rates on banks?
● Banks who charge negative rates are more profitable and could lend more.
Banks do lend more because cheaper lending promoted firms to borrow more. Hence, the boosted economy offsets the negative effects of NIRP that is decreased intermediation margins.
● Positive effects of NIRP on economy are stronger if banks are healthy and can charge negative i rates on deposits
* Preserving bank profitability and intermediation capacity in negative i periods important!
What are the differences of weak and sound banks during negative interest rates?
With positive i rates, policy is transmitted by weak banks, as they have relaxed constraints (weak banks generally lend more) when policy i rates drop; healthy banks are more strict on their lending
Below ZLB, healthy banks transmit policy better than weak (have strong market power during NIRP as they have high credit ratings, firms have a demand for safe assets)
What happens to the deposit outflows when banks implement negative rates?
Deposit growth is higher after banks start imposing negative rates on deposits comparing to ZLB. And weak banks experience lower deposit growth in the first months.
Does the amount of pass-through depend on the health of the bank?
Weaker banks used to pass most of the effect, because they generally lend more.
Why have some central banks recently started to exempt some bank reserves from negative interest rates?
Improve bank health (by exempting neg. i on bank reserves in CB) –> transmit negative i rates to corp. deposits –> corporations don’t deposit in bank –> directly stimulate investment elsewhere
