How Low Can Central Banks Go? The Banking Threshold to Negative Interest Rates

Abstract

Abstract Negative interest rates policies (NIRP), usually depicted in economic textbooks as an impossibility due to the prospect of infinite demand for money, are now a reality in several countries due to different reasons. But while the ZLB has been surpassed when it comes to Central Banks, it has been transferred to commercial banks through the fear of a flight from savings and time deposits, making banks suffer additional losses in profits, and limiting the reach of NIRP. In this paper we develop a model to study the adoption of NIRP in an environment of elevated excess reserves. We find that 1) despite the central banks being freed from the ZLB, having banks put a cap on the rate charged on its deposits effectively maintains the negative economic effects of the ZLB and; 2) NIRP is helpful and very negative rates feasible for a short time, but it might become a growing burden and can actually hurt the economic recovery, specially if accompanied by heavy liquidity intervention by the CB.