Negative Deposit Rates as a Central Bank’s Policy Tool - Theory Overview and Experiences from Europe

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School of Business | Bachelor's thesis

Date

2019

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Mcode

Degree programme

Taloustiede

Language

en

Pages

25

Series

Abstract

This paper uses the theoretical framework of zero lower bound and the transmission channels of monetary policy to inspect why the interest rates cannot go negative and how the adjustments of central banks deposit rate transmit to the real economy. I review these presented theories by comparing them to the empirical results obtained from the banking sector of Europe to determine why the central banks deposit rates have been able to go negative and if there are any adverse effects related to this crossing of zero lower bound. For the theoretical framework I mainly use the transmission channels presented by Mishkin (1996), mathematical presentation of zero lower bound by McCallum (2000) and empirical results from several authors. I find that the deposit rate mainly operates through the bank lending channel, but this specific channel has not been operating according to the theory especially after the financial crisis. I also find that of all the different interest rates, the zero lower bound concerns most specifically the deposit rate, as it determines whether it is profitable to hold assets as deposits or as cash and that it has to be always lower than lending rate, therefore possibly breaking the zero lower bound always first. The absoluteness of the zero bound however has not been tested yet empirically, as no commercial bank has introduced a negative deposit rate that would concern all their clients, even though central banks have implemented negative deposit rates. I also find that the banking sector has been able to absorb the costs of narrowed margins by increasing other forms of income, such as fees, and no notable risks has arisen during the period of negative interest rates.

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Thesis advisor

Mustonen, Mikko
Murto, Pauli

Keywords

negative interest rate, deposit rate, zero lower bound, transmission channel

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