Negative rates and the transmission of monetary policy

Miguel Boucinha and Lorenzo Burlon of ECB in this article:

The stimulus to the broader economy provided by NIRP has been effective in inducing an easing of financing conditions and thereby, ultimately, contributing to price stability. The interest rate cut has been channelled through both standard and non-standard transmission mechanisms, generating a reduction in bank funding costs and spurring loan creation. Effects were heterogeneous across bank characteristics. However, the dispersion in some bank responses does not challenge the overall positive first-order effect of NIRP on financing conditions. Notwithstanding the potential headwinds to transmission discussed above, as yet there is no sign that the stimulus provided by the measure has been exhausted, as new channels emerge while others fade away. Ultimately, the macroeconomic response has been sizeable and has helped to bring inflation closer to the ECB’s aim.

Protracted periods of negative rates do, however, have the potential to hinder the transmission of monetary policy. Prolonged periods of negative rates are qualitatively different from brief, “experimental” periods. If negative policy rates had proved to be short-lived, they might have become a mere footnote in central banking history. As negative rates persist, however, banks react to them to avoid the negative effects on profitability, although their leeway to do so is eroded over time. In the current euro area monetary policy environment, the effects of a long period of negative rates require continuous and careful monitoring as we venture further into uncharted territory.

Overall, NIRP still largely benefits the macroeconomic outlook and price stability. In order to support the bank-based transmission of monetary policy, the ECB has adopted a two-tier system for reserve remuneration. In parallel, specific risks to financial stability are addressed by action from other policy areas, which are specifically mandated to tackle phenomena and behaviours associated with such risks. Microprudential supervision monitors banks’ risk-taking behaviour, and so far it has provided an adequate set of incentives for intermediaries to calibrate their risk attitude to the macroeconomic circumstances. Moreover, national and supranational macroprudential authorities can effectively monitor and respond to localised house price bubbles and other threats to financial stability. Such mitigating action allows the euro area economy to continue to benefit from the significant and necessary stimulative impact of NIRP, which has proven to be an integral and effective part of the ECB’s policy response to past and current challenges.


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