Monetary Policy Implementation in a Negative Rate Environment

• Published date: 01 March 2020
• Author: MICHAEL BOUTROS,JONATHAN WITMER
• Date: 01 March 2020
• DOI: http://doi.org/10.1111/jmcb.12605

DOI: 10.1111/jmcb.12605

MICHAEL BOUTROS

JONATHAN WITMER

Monetary Policy Implementation in a Negative Rate

Environment

Toanalyze monetary policy implementation in a negative rate environment,

we add the option to exchange central bank reserves for cash to the stan-

dard workhorse model of monetary policy implementation (Poole 1968).

Importantly, we show that monetary policy can be constrained when the

target overnight rate is below the yield on cash. At this point, the overnight

rate equals the yield on cash instead of the target rate. Modifications to the

implementation framework, such as a reserve requirement that varies with

cash withdrawals, can help restore the implementation of monetary policy

such that the overnight rate equals the target rate.

JEL codes: E, E4, E40, E42, E43, E5, E58

Keywords: interest rates, monetary policy implementation, monetary

policy framework.

CENTRAL BANKS HAVE SIGNIFICANTLY ALTERED their monetary

policy implementation frameworks in the aftermath of the financial crisis. First,

quantitative easing resulted in anincrease in central bank reserves, which significantly

changed trading incentives and behavior in the market for overnight reserves. For

example, in 2008, the Federal Reserve introduced interest on reserves as a way to

maintain influence over the overnight rate because of a significant increase in reserves

(Klee, Senyuz, and Yoldas 2016). More recently, several central banks, including the

European Central Bank (ECB), the Swiss National Bank (SNB), and the Bank of

Japan (BoJ), have adopted negative policy rates.

Central banks implement monetary policy differently, and it is not apparent how

differences in monetary policy implementation frameworks matter in a negative rate

We thank Jason Allen, Greg Bauer, David Cimon, Falko Fecht, Corey Garriott, Todd Keister, Chris

Sutherland, Jing Yang,our anonymous referee, and seminar participants at the Bank of Canada, European

Central Bank, and Duke University for helpful comments. All remaining errors are our own.

MICHAEL BOUTROS is at Duke University (E-mail: michael.boutros@duke.edu). JONATHAN WITMER is at

Financial Markets Department, Bank of Canada (E-mail: jwitmer@bankofCanada.ca).

Received August 25, 2017; and accepted in revised form December 4, 2018.

Journal of Money, Credit and Banking, Vol. 52, Nos. 2–3 (March–April 2020)

C

2019 The Ohio State University

442 :MONEY,CREDIT AND BANKING

TAB LE 1

NEGATIVE CENTRAL BANKRATES AS OF NOVEM BER 2016 (BPS)

Country Negativerates introduced Lending rate Depositrate

Danmarks Nationalbank July 2012*5−65

European Central Bank June 2014 25 −40

Swiss National Bank Dec. 2014 50 −75

Swedish Riksbank Feb. 2015 25 −125

Bank of Japan Jan. 2016 10 −10

Hungarian National Bank March2016 115 −5

*The Nationalbank temporarily raised rates into nonnegativeterritory between April and September 2014.

environment. Most central banks operate by setting a target for the overnight interest

rate, along with rates on standing facilities through which participants can borrow

from or deposit with the central bank (Borio 1997). Some central banks, like the Bank

of Canada, operate a corridor system whereby the target rate is in the middle of a

corridor bounded by the (higher) borrowing rate and the (lower) deposit rate. Others

operate a floor system, so named because the target rate is equal to the deposit rate at

the bottom of the interest rate corridor. Some central banks have even adapted their

frameworks as they lowered their policy rates into negative territory. The SNB, for

instance, has transitioned to a tiered system for the remuneration of deposits (Swiss

National Bank 2014), where a predetermined level of deposits is exempt from the

negative deposit rate and compensated at a rate of zero. Any deposits above this

amount are compensated at a negative rate, meaning banks pay the SNB for these

deposits. How were these changes important for the implementation of monetary

policy in a negative rate environment?

Monetary policy implementation is concerned with how short-term (usually

overnight) interest rates are determined and is the starting point of the monetary

policy transmission mechanism. Understanding the impact of negative rates on mon-

etary policy implementation is of practical importance since negative interest rates

are becoming more common. Over USD 13 trillion of sovereign bonds have now

traded at negative rates (Whittall and Goldfarb 2016). And sovereign bond yields in

some countries were negative beyond 10 years of maturity, suggesting that negative

rates were not expected to be a passing phenomenon.

As recently as the end of 2016, central banks with negative rates have a wide

range of deposit rates, ranging from −5 bps to −125 bps (Table 1). This could reflect

differences in the effective lower bound (ELB) in these countries, which could be

related to differences in monetary policy implementation frameworks. It also could

reflect the fact that some central banks have not yet hit their ELB, given that yields

on cash may be more negative than current overnight rates. This may still be above

the negative yield on cash after incorporating the costs of holding and using cash:

estimates of the costs of storing and using cash could range from 25 bps (Witmer and

Yang 2016) up to 200 bps (Vi˜

nals, Gray, and Eckhold 2016).