Negative Nominal Interest Rate Policy - Motivations Implementation and Risks Pia-Katharina Andres

Negative nominal interest rate policy: motivations,
implementation and risks

Pia-Katharina Andres
Supervisor: Professor Richard Dennis
University of Glasgow, Scotland, United Kingdom
5 April 2017
Submitted in partial fulfilment of the requirements for the degree of Master of Arts
(Social Sciences) with Honours, Economics.
Abstract
Expansionary monetary policy was traditionally thought to be restricted by the zero

lower bound on nominal interest rates. Yet since 2014, some central banks facing secular
stagnation and deflationary traps have pushed key policy rates below zero. This paper
reviews the theoretical literature on the zero lower bound and proposals to overcome it. It
then outlines how negative nominal interest rates have been implemented in practice, and to
what effect. Evidence suggests that rates have not yet reached their effective lower bound,
which appears to be below zero. Potential adverse effects of negative nominal rates are
also considered. The paper concludes that negative rates have had mixed success, and are
insufficient to address secular stagnation on their own.
1
MA Hons, Economics Dissertation Pia-Katharina Andres
Contents
List of Figures 3
1 Introduction 5
2 The lower bound on nominal interest rates and ways to overcome it 7

2.1 The lower bound on nominal interest rates: causes and impact . . . . . . . . . . 7
2.2 The lower bound on interest rates as a policy constraint . . . . . . . . . . . . . . 8
2.3 Abolishing paper currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.4 Taxing paper currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.5 Decoupling paper currency from the unit of account . . . . . . . . . . . . . . . . 10
2.6 Further proposals and considerations . . . . . . . . . . . . . . . . . . . . . . . . . 11
3 How central banks have implemented negative nominal policy rates 13

3.1 European Central Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
3.2 Denmarks National Bank (Danmarks Nationalbank) . . . . . . . . . . . . . . . . 14
3.3 Swiss National Bank (Schweizerische Nationalbank) . . . . . . . . . . . . . . . . 15
3.4 Central Bank of Sweden (Sveriges Riksbank) . . . . . . . . . . . . . . . . . . . . 16
3.5 Bank of Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
3.6 National Bank of Hungary (Magyar Nemzeti Bank) . . . . . . . . . . . . . . . . . 19
3.7 Bank of Norway (Norges Bank) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.8 Further remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
4 Effects, dangers and risks 21

4.1 Empirical effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
4.2 Discussion and limitations of empirical evidence on the lower bound . . . . . . . 24
4.3 Dangers and risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
4.4 Effectiveness of negative nominal interest rates and policy alternatives . . . . . . 27
5 Conclusion 29
Bibliography 31
Appendix 35
A European Central Bank 35
B Danmarks Nationalbank 40
C Schweizerische Nationalbank 46
D Sveriges Riksbank 53
E Bank of Japan 58
2
List of Figures
1 European Central Bank, policy rates. . . . . . . . . . . . . . . . . . . . . . . . . . 14
2 Danmarks Nationalbank, policy rates. . . . . . . . . . . . . . . . . . . . . . . . . 15
3 Schweizerische Nationalbank, target range and 3-month LIBOR. . . . . . . . . . 16
4 Sveriges Riksbank, policy rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
5 Bank of Japan, main policy rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
6 Euro area, interbank rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
7 Euro area, government bond yields. . . . . . . . . . . . . . . . . . . . . . . . . . . 36
8 Euro area, borrowing conditions and volume for non-financial corporations. . . . 36
9 Euro area, borrowing conditions and volume for households and non-profit insti-
tutions serving households (all purposes). . . . . . . . . . . . . . . . . . . . . . . 37
10 Euro area, borrowing conditions and volume for house purchase. . . . . . . . . . 37
11 Euro area, volume of new private sector loans. . . . . . . . . . . . . . . . . . . . 38
12 Euro area, annualised agreed rate on overnight deposits and deposits with agreed
maturity (over 2 years original maturity), new business coverage. . . . . . . . . . 38
13 Euro area, currency in circulation. . . . . . . . . . . . . . . . . . . . . . . . . . . 39
14 Euro area, inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
15 Euro area, GDP at 2010 prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
16 Denmark, interbank rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
17 Denmark, bond yields. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
18 Denmark, borrowing conditions and volume for non-financial corporations. . . . . 41
19 Denmark, borrowing conditions and volume for households (all purposes). . . . . 42
20 Denmark, borrowing conditions and volume for house purchase. . . . . . . . . . . 42
21 Denmark, annualised agreed rate on deposits with agreed maturity and repos by
non-financial corporations in the MFI sector. . . . . . . . . . . . . . . . . . . . . 43
22 Denmark, annualised agreed rate on deposits with agreed maturity and repos by
households in the MFI sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
23 Denmark, currency in circulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
24 Euro to DKK exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
25 Denmark, GDP at 2010 prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
26 Denmark, inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
27 Switzerland, interbank rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
28 Switzerland, government bond yields. . . . . . . . . . . . . . . . . . . . . . . . . . 46
29 Switzerland, yield curve. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
30 Switzerland, interest on investment loans. . . . . . . . . . . . . . . . . . . . . . . 47
31 Switzerland, interest on fixed-rate mortgages. . . . . . . . . . . . . . . . . . . . . 48
32 Switzerland, interest on variable-rate mortgages. . . . . . . . . . . . . . . . . . . 48
33 Switzerland, volume of corporate loans. . . . . . . . . . . . . . . . . . . . . . . . 49
34 Switzerland, total credit volume. . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
35 Switzerland, interest on bank deposits. . . . . . . . . . . . . . . . . . . . . . . . . 50
36 Switzerland, currency in circulation. . . . . . . . . . . . . . . . . . . . . . . . . . 51
37 Euro to CHF exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
3
38 Switzerland, change in GDP at previous years prices. . . . . . . . . . . . . . . . 52

39 Switzerland, inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
40 Sweden, interbank rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
41 Sweden, treasury bill yields. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
42 Sweden, government bond yields. . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
43 Sweden, cost and volume of borrowing by non-financial corporations. . . . . . . . 54
44 Sweden, cost and volume of borrowing by households. . . . . . . . . . . . . . . . 55
45 Sweden, interest on bank deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . 55
46 Sweden, currency in circulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
47 Euro to SEK exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
48 Sweden, change in GDP per capita (denominated in EUR). . . . . . . . . . . . . 57
49 Sweden, inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
50 Japan, interbank rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
51 Japan, government bond yields. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
52 Japan, cost and volume of borrowing by the private sector. . . . . . . . . . . . . 59
53 Japan, interest on bank deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
54 Japan, currency in circulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
55 US dollar to yen exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
56 Japan, real GDP, annualised rate of change. . . . . . . . . . . . . . . . . . . . . . 61
57 Japan, inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
4
1 Introduction
Economists have traditionally considered accommodative monetary policy to be subject to a
zero lower bound on nominal interest rates. This is because economic actors are presented with
a choice to substitute for paper currency, which earns an interest rate of 0%.
In the context of secular stagnation in many advanced economies and nominal policy rates
at or near 0%, central banks have moved towards unconventional measures, most notably large-
scale asset purchase programmes known as quantitative easing. The lower bound on nominal
interest rates and the possibility of pushing rates below zero have also gained increased attention.
Since 2014, four central banks in Europe, as well as the Bank of Japan, have moved key policy
rates into negative territory, showing that the effective lower bound on interest rates appears to
be located below zero.
This dissertation discusses negative nominal interest rate policy from a theoretical and an
empirical point of view. It first examines the main proposals for overcoming the lower bound on
nominal interest rates. The discussion then moves on to central banks motivations for imple-
menting negative rates, their practical implementation, and the effects they have had. Finally,
it explores potential dangers associated with the policy. The dissertation contributes to the
academic literature by providing a comprehensive overview of the central aspects of the debate
on negative nominal interest rates. It combines a discussion of the theoretical literature on the
zero lower bound with an empirical investigation of how negative nominal interest rate policy
has played out in practice, two issues which were previously discussed mainly in separation.
The dissertation also provides a detailed discussion of each central bank which has implemented
negative nominal rates to date.
The paper is structured as follows. Section 2 gives an overview of the theoretical literature
on the lower bound on interest rates and the three main proposals put forward to overcome it:
abolishing paper currency; taxing it; and decoupling its value from the unit of account. The
section concludes that the likelihood of success for each proposal depends largely on the cultural
and economic context in which it is to be implemented. It also comments on the possibility that
paper currency may be replaced as a store of value by other liquid assets.
Section 3 outlines the context and manner in which central banks have implemented nega-
tive nominal policy rates. Central banks which have implemented such policies are the European
Central Bank, the Danish National Bank, the Swiss National Bank, the central bank of Swe-
den, the Bank of Japan, and to some degree the central banks of Hungary and Norway. The
motivations behind these decisions were typically the need to stimulate economic activity and
inflation and/or to ease appreciation pressures on the local currency. Most of the central banks
in question apply negative rates only to a fraction of bank reserves. None of them experienced
considerable difficulties in implementing their policy decisions.
5
Section 4 discusses the effects of negative nominal policy rates in the Eurozone, Denmark,
Switzerland, Sweden and Japan. An empirical analysis finds that while such policies appear to
have been successful where their objective was to alleviate appreciation pressures on the local
currency, their impact on lending, output growth and inflation has been modest. Although
negative nominal policy rates may have averted worse outcomes than what has been observed,
growth rates and inflation remain well below target in most of the jurisdictions discussed. There
is no evidence of cash hoarding, indicating that rates have not yet reached the effective lower
bound.
Section 4 also provides a summary of the main dangers associated with negative nominal
rates: dis-intermediation due to a substitution for cash; resistance by a public which perceives
negative rates as unnatural; the erosion of bank profitability resulting in worse, rather than
improved, lending conditions; and decreased financial stability. The first two risks relate to the
physical lower bound on interest rates, which was traditionally thought to be at zero, but is
likely to be below it. The latter two relate to the concept of an economic lower bound or re-
versal rate: a point at which lowering interest rates no longer has the effect of easing monetary
conditions, and below which conditions may even worsen.
The paper concludes that while negative nominal interest rate policy may be necessary in
order to prevent real interest rates from being undesirably high in a stagnant, low-inflation
environment, economies rely to an undue extent on monetary stimulus. Fiscal stimulus and
structural reforms may be required to address secular stagnation.
6
2 The lower bound on nominal interest rates and ways to over-

come it
The zero lower bound on nominal interest rates as a constraint on expansionary monetary
policy in a low inflation environment is well-documented in the literature. Proposals on how to
eliminate it were brought forward in the early 20th century by Silvio Gesell and as potential
remedies during the great depression years by Robert Eisler, discussed by John Maynard Keynes,
and advocated by Irving Fisher. John Hicks wrote on the lower bound:
If the costs of holding money can be neglected, it will always be profitable to

hold money rather than lend it out, if the rate of interest is not greater than zero.
Consequently the rate of interest must always be positive. (Hicks, 1937)
In the context of present-day monetary policy, imposing a negative interest rate on bank de-
posits or commercial banks reserves with the central bank should be uncomplicated. However,
paper currency has traditionally earned a nominal interest rate of zero, because of the apparent
logistical impossibility of paying (or charging) interest on it. This is the main issue identified
in the literature. It would be impossible to verify how much interest was due under the current
system, and even harder to enforce a negative interest rate: the holders of currency could simply
refuse to come forward to pay it. Paper currency can be used and transferred anonymously, and
its holders can hardly be identified as due to receive or pay interest (Buiter, 2009).
Where exactly the lower bound on nominal interest rates is and whether and how it can be
overcome has increasingly become a practical concern. Japan entered a deflationary trap at the
end of the previous century (Buiter, 2005) and several other advanced economies followed in the
aftermath of the 2008 crisis (Buiter, 2009). This section discusses the origins of the lower bound,
the extent to which it represents a constraint on expansionary interest rate policy, and the three
main proposals put forward to eliminate it: abolishing paper currency; taxing it; and creating a
variable, but targeted exchange rate between paper and digital currency. The practicalities and
limitations of each mechanism are also discussed.
2.1 The lower bound on nominal interest rates: causes and impact
While the lower bound on nominal interest rates is often said to be zero, this may not strictly be
the case. Recent policy decisions by five central banks to lower key policy rates below zero have
not led to cash hoarding by commercial banks. This should not be taken as sufficient evidence to
dismiss the option of hoarding cash as a serious constraint. There are considerable costs involved
in securely storing large amounts of paper currency. The lower bound on nominal interest rates is
therefore likely to be below zero where large quantities of money are involved, and will depend on
how long interest rates are expected to remain in negative territory (Bech and Malkhozov, 2016).
The possibility that under some circumstances the lower bound may be hit at a positive
rate of interest has also been considered (Yates, 2002). This would be the case if there were
benefits to holding paper currency (such as liquidity or anonymity) which exceeded both storage
7
costs and a certain positive rate of interest on lending money in the form of bank deposits or
otherwise. However, recent developments do not suggest that this is a serious concern.
2.2 The lower bound on interest rates as a policy constraint

Central banks target interest rates to achieve their desired level of inflation. A crucial channel
of the monetary transmission mechanism is demand management, which in recent years has
increasingly become a monetary policy goal in its own right. What is usually thought to matter
most in practice are real interest rates, which are obtained by deducting the level of inflation from
nominal rates. At positive levels of inflation, real interest rates can easily go negative. In a low,
zero or negative inflation environment, the lower bound on nominal interest rates can mean that
real rates are sub-optimally high. When nominal rates are at their lower bounds and inflation re-
mains below target, the economy has entered a liquidity trap (Buiter and Panigirtzoglou, 1999).
After the high-inflation years of the second half of the 20th century, the danger of entering
a liquidity trap was viewed as more of an academic concern:
Overall, the risks of being trapped at the zero bound to interest rates are probably
small, and probably overstated. (Yates, 2002)
However, times have changed. Inflation has been consistently below the central banks targets
in several advanced economies, including the UK (prior to the recent Sterling depreciation in
response to the EU referendum), the Eurozone and Japan. The US Federal Reserve kept its
Federal Funds target range near zero for almost eight years after the 2008 financial crisis (Neate,
2016). In the Eurozone in particular, economic growth has been slow, and inflation at times
even negative (Gimdal and Karakas, 2016; Hannon, 2016).
Amidst these circumstances, combined with a political climate favouring fiscal austerity, cen-
tral banks turned to unconventional policy instruments; most notably, large-scale asset purchase
programmes also known as quantitative easing (Borio and Disyatat, 2009). Some also began
to move policy rates into negative territory (Bech and Malkhozov, 2016). The lower bound on
interest rates has thus become a potentially binding constraint on current policy. The remainder
of this section will provide an overview of the main proposals to eliminate the lower bound.
2.3 Abolishing paper currency

Abolishing paper currency presents itself as an obvious way to eliminate the lower bound on
nominal interest rates, which is thought to be caused by the existence of currency as a liquid,
risk-less and interest-free way of storing money. Paper currency is exceedingly used only for
small payments, if at all, in many economies. Its abolition is therefore sometimes considered
a relatively hassle-free affair with the added effect of impeding black-market and other illegal
activities (cf. Buiter, 2009). In a cashless economy, nominal interest rates could theoretically
become as negative as thought desirable - unless economic agents chose to substitute another
type of safe, liquid asset for deposits, a limitation which applies to all three proposals and will
8
be discussed further in section 2.6.
Consideration should be given to several issues potentially arising from such a move. The
ease with which paper currency could be abolished and the readiness with which this would be
accepted by the general populace may vary between countries. Sweden is seen as the champion
of de-facto cashless societies: its central bank estimates that paper currency in circulation makes
up less than 2% of GDP (Sveriges Riksbank, 2016b) and cash payments are frequently refused
even during small transactions such as paying a taxi fare (Heller, 2016). Contact-less, credit or
debit card payments are also exceedingly common in other countries. However, elsewhere paper
currency is used more frequently: in Japan, for example, it is used for the vast majority of retail
transactions (Mayger and Anstey, 2016). Under such circumstances the decision to abolish cash
may be met with substantial resistance and disrupt day-to-day economic life. It would also
involve additional costs to businesses who do not possess card payment facilities, which would
likely affect small businesses disproportionately. These necessary investments could of course be
subsidised by government.
In a society resistant to the abolition of paper currency the latter might be replaced by
alternative means of payment offering a similar level of anonymity and liquidity. Anything can
be used as a medium of exchange as long as it is accepted by those one wishes to trade with and
can be carried without unreasonable effort.1
While the prospect of impeding illegal activities and tax fraud by making anonymous pay-
ments impossible may sound appealing, consideration should also be given to the question of
civic rights. Abolishing anonymous payments altogether could be seen as an infringement upon
rights to data protection, civil liberty, and privacy.
Abolishing cash would also prevent the economic participation of agents who do not have
bank accounts, despite not being involved in illegal activities. This may include children and the
homeless. Immigrants, particularly those without legal status, would also be extremely vulnera-
ble. While their labour force participation falls under illegal activities and some might welcome
their exclusion, it remains a contentious political and economic issue.2
Less radical proposals involve measures to effectively phase out paper currency. Rogoff
(2016) proposes that holding large sums of money be made more difficult by the abolition of
large banknotes. Kimball (2013) suggests that stripping paper currency of its legal tender status
might make cash less attractive as a store of value, without removing its function as a means of
payment (at least for smaller transactions).
1
The familiar example of cigarettes as a type of currency among prison populations comes to mind.
2
Some industries rely on illegal migrant labour. As an example, consider the disruption caused by the departure
of Latino immigrant workers from Georgia (2011) and Alabama (2012) fields due to particularly harsh immigration
laws, which resulted in crops rotting on the fields (Powell, 2012; Strupp, 2012).
9
2.4 Taxing paper currency

Buiter (2009) and others attribute the suggestion to impose a carry tax on paper currency
to Silvio Gesell, who proposed introducing a chargeable, monthly stamp required in order for
banknotes to retain their value (Gesell and Pye, 1958). The purpose of this proposal was to
prevent money hoarding, an idea favoured also by Fisher (1933).
Inspired by Gesell, an alternative currency called Wara was temporarily used in some Ger-
man communities in the early 1930s. At the time, the Reichsmark tended to be hoarded due
to the uncertain economic environment, and the resulting insufficient supply of currency in cir-
culation further depressed economic activity. The Wara had to be stamped weekly at a rate
of 2% of its value, which led to its faster circulation. The resulting revival of one communitys
economy became known as the miracle of Schwanenkirchen. A similarly successful experiment
using stamp scrip was carried out in the Austrian town Woergl, and some areas in the United
States followed these examples. The scrip currencies were later deemed illegal in Germany and
Austria (Fisher, 1933).
Thanks to more advanced technology a carry tax on paper currency could now be imposed
via more sophisticated means than by using a stamp (which would be highly vulnerable to coun-
terfeiting). Goodfriend (2000) proposes implanting a magnetic strip in each banknote in order
to monitor when the bill was last withdrawn, and to tax it accordingly.
Buiter and Panigirtzoglou (1999) highlight the danger that unstamped currency may continue
to be accepted as a means of payment. In order to enforce the carry tax, they propose a more
visible distinction than that proposed by Goodfriend, such as a stamp. They also suggest it
may be necessary to introduce a penalty on those who hold currency on which the carry tax or
negative interest has not been paid, such as confiscation (Buiter and Panigirtzoglou, 1999).
2.5 Decoupling paper currency from the unit of account

Paper and digital currency commonly hold the same value and can be exchanged at a ratio of 1:1.
Robert Eisler envisaged a distinction between the values of bank money and paper currency
(Eisler, 1932). Buiter (2009) provides a number of historical examples in which the unit of
account differed from the medium of exchange. In practice, paper currency could be abolished
and replaced by a currency of a different name, or it could remain as it was but be stripped of
its parity in value with electronic money.
Modern proposals based on this idea, such as time-varying deposit fee at the central banks
cash window suggested by Kimball (Agarwal and Kimball, 2015; Kimball, 2015) or the euro and
wim economy described by Buiter (2009), emphasise the imposition of a controlled exchange
rate between digital and paper currency. This exchange rate could be achieved by imposing
a variable deposit or withdrawal fee, either on all bank deposits/withdrawals or only at the
central bank (Agarwal and Kimball, 2015). Alternatively, instead of using a fee as such, the
10
central bank might simply set an exchange rate and treat commercial banks cash deposits (or
withdrawals) accordingly, requiring banks to do the same. If, for instance, at a given point
in time the exchange rate stood at 1.1 units of paper currency to 1 unit of digital currency, a
person depositing 1 unit of paper currency at a commercial bank would only see their account
credited by 0.99 units of digital currency. This would be because the same principle would apply
to commercial banks depositing (or withdrawing) reserves at the central bank.
Retaining the digital currency as the unit of account could be required by law, meaning that
contracts, taxes and such would have to be denominated in the digital currency. During periods
in which nominal policy rates are negative, the paper currency would be made to depreciate
against the electronic currency. Parity could be re-established whenever rates are positive, or
paper currency could be made to appreciate during such times.
An important limitation is the danger that the public might resist using the digital currency
as the unit of account, and refer to the paper currency instead, if unofficially (Buiter, 2009). In
effect, then, digital money would gain value, instead of paper currency losing it. Furthermore,
the policy might result in significant menu costs for businesses if both prices were to be provided
at all times and the exchange rate changed frequently.
2.6 Further proposals and considerations

Variations of or similar proposals to those discussed above exist, such as Mankiws (2009) sugges-
tion to randomly invalidate banknotes based on their serial number (in regular intervals), thus
discouraging their hoarding. However, such a policy would again be prone to the danger that
economic agents might continue to accept invalidated banknotes (Buiter, 2009). They would
need to be discouraged from doing so by the threat of legal repercussions.
In essence, proposals to eliminate the zero lower bound always aim to prevent cash hoarding.
The biggest threat to their effectiveness is therefore the possibility of public resistance. Even if
paper currency were abolished completely, people might turn to other assets to replace it, such
as precious metals or foreign currencies. As Keynes pointed out, dismissing Gesells stamped
currency,
money [is] not unique in having a liquidity-premium attached to it, but differ[s]
only in degree from many other articles [...] if currency notes were to be deprived of
their liquidity-premium by the stamping system, a long series of substitutes would
step into their shoes [...] (Keynes, 1936/1939)
Opinions on the likelihood of this occurring vary (cf. Goodfriend, 2000), but it is a danger that
should not be dismissed outright. Negative nominal interest rates, especially if they were im-
posed on individual savers, might prove politically controversial. The argument that negative
real interest rates have always existed and been accepted without further protest is not a re-
liable prediction of public reactions. Public awareness of inflation levels and knowledge of the
difference between nominal and real interest may not be as strong as economists might hope. In
11
other words, the public is likely to exhibit money illusion.
Moreover, the more negative nominal rates become, the more likely it seems that each mech-
anisms limitations might come into play. If paper currency were abolished, the only way to
circumvent the negative rate would be to substitute for other safe, liquid assets. Parallel cur-
rencies might appear. If paper currency were to depreciate against digital currency or be taxed,
resistance to the policy through continued use of unstamped cash or use of paper currency as
the unit of account might be more likely to emerge at increasingly negative levels of interest
rates than only slightly negative ones.
Any choice of steps to eliminate the lower bound should thus be evaluated with a view to
the specific cultural and political context in which they are to be implemented. In countries like
Sweden, phasing out or abolishing paper currency might be feasible. Elsewhere, a currency tax
or exchange rate might prove more effective.
The next section will discuss the experiences of central banks who have pushed policy rates
below zero.
12
3 How central banks have implemented negative nominal policy

rates
Negative nominal interest rates on commercial banks reserves have been imposed since 2014
(and in some cases even earlier than that). This section outlines the experience of seven central
banks which have lowered at least one nominal policy rate below zero to date: The European
Central Bank and the central banks of Denmark, Switzerland, Sweden, Japan, Hungary and
Norway.3 The section discusses the experience of the central banks in question with regard
to the respective context and motivation for implementing negative nominal rates, the policys
practical implementation, and whether it differed from conventional interest rate policy.
It should be noted that while this paper focuses primarily on negative policy rates, negative
nominal rates or yields determined by the market are not entirely new. Investors may accept
negative short-term rates for a variety of reasons, such as a flight to safety in an unstable
financial environment; very low inflation and a lack of profitable and/or safe alternative invest-
ment opportunities; the use of government bonds and similar assets as collateral in repurchase
agreements; and exchange rate speculation. Particularly in the immediate aftermath of the fi-
nancial crisis, short- and medium-term yields on treasury bills and government bonds considered
safe occasionally became negative. Furthermore, Switzerland used a type of negative interest
rate policy as early as the 1970s, when it imposed negative short-term rates on foreigners bank
deposits as part of wider efforts to ease appreciation pressures on the franc (Jorgensen and
Risbjerg, 2012).
3.1 European Central Bank

On 11 June 2014, the European Central Bank cut its deposit facility rate to -10 basis points. It
has since been cut further, and currently stands at -40bp (Figure 1).
Context for implementing negative rates The ECBs deposit rate had been at 0%
since mid-2012; various asset purchase programmes had been implemented since July 2009.
Inflation fell below the ECBs target of 2% in late 2012, and continued to decrease, to an
average of 0.3% when negative policy rates were first introduced. The economy was sluggish
(cf. Gimdal and Karakas, 2016). The aim of negative policy rates was to stimulate growth and
bring inflation back up to target (Coeure, 2016).
Implementation On 5 June, the ECB set out the details of how a negative interest rate
on deposits with Eurosystem national central banks would be implemented (European Union,
2014). Deposits held by commercial banks at national central banks exceeding minimum reserve
requirements, and government deposits in excess of 200 million or 0,04% of the gross domestic
3
The central banks of Hungary and Norway are rarely mentioned in the empirical literature on negative nominal
interest rate policy. This is because they have pushed only marginal rates into negative territory, rather than
key policy rates. Their negative rates do not apply to any substantial amount of commercial bank deposits and
are therefore not expected to impact financial markets (cf. Jobst and Lin, 2016). They are briefly covered in this
section for completeness.
13
Figure 1: European Central Bank, policy rates.
Source: ECB Statistical Data Warehouse
product of the respective member state, are to be remunerated at 0% or the deposit facility
rate, whichever is lower. A non-negative rate applies below the threshold. A negative interest
rate is defined as a payment obligation of the deposit holder to the relevant Eurosystem central
bank including the right of that Eurosystem central bank to debit the account of the counter-
party accordingly. (European Union, 2014) Deposits related to European Union/International
Monetary Fund and other comparable financial support programmes are exempt and earn an
interest rate of no less than zero (European Union, 2014).
3.2 Denmarks National Bank (Danmarks Nationalbank)

Danmarks Nationalbank first cut its certificate of deposit rate to -20bp in July 2012 (Jorgensen
and Risbjerg, 2012). The rate was briefly raised to 5bp in early 2014, and cut down again to
-5bp on 5 September 2014. Its lowest level yet was -75bp in early 2015, and it currently stands
at -65bp (Figure 2).
Context for implementing negative rates The Nationalbanks monetary policy objec-
tive is to maintain a stable exchange rate (746.038 kroner per 100 euro with a fluctuation band
of +/-2.25%) with the euro. Policy decisions are therefore often made in response to euro area
policy (Jorgensen and Risbjerg, 2012). In 2014, the Nationalbank lowered its certificate of de-
posit rate to -5bp to counter-act appreciation pressures resulting from the preceding interest cut
by the ECB (Fremmich Andresen et al., 2015). Further reductions down to -75bp in February
2015 were in part a consequence of interest rate decisions by the Swiss National Bank, which
further increased appreciation pressures on the Danish kroner (Bech and Malkhozov, 2016).
14
Figure 2: Danmarks Nationalbank, policy rates.
Source: Thomson Reuters
Implementation In Denmark, commercial banks current account holdings earn a current

account rate (currently at 0%) and must not be negative or exceed a certain threshold at 3.30pm
each day. When negative certificate of deposit rates were first introduced in July 2012, the
threshold for holding current account balances was raised from 23.15 to 69.70 billion kroner to
reduce the strain of a negative rate [...] on the monetary-policy counterparties. (Jorgensen and
Risbjerg, 2012) Holdings exceeding this upper limit at the time of settlement must be converted
into certificates of deposit with a maturity of one week.
3.3 Swiss National Bank (Schweizerische Nationalbank)

In December 2014, the Swiss National Bank announced the introduction of an interest rate of
-25bp on sight deposits exceeding a certain threshold from 22 January 2015. In January 2015
it lowered the rate to -75bp. Its target range for the 3-month LIBOR has since stood at -1.25
-0.25% (Figure 3).
Context for implementing negative rates In September 2011, the SNB had intro-
duced an exchange rate floor of CHF 1.20 against the euro to counter-act the over-valuation
of its currency (cf. Hildebrand, 2011). In late 2014, it announced its decision to introduce a
negative interest rate on sight deposits to offset newly increased appreciation pressures caused
by monetary easing in the euro area (Swiss National Bank, 2014). On 15 January 2015, the SNB
discontinued its exchange rate floor and instead lowered the rate on sight deposits further to
-75bp. This decision was motivated by the euros sharp depreciation against the dollar, which in
15
Figure 3: Schweizerische Nationalbank, target range and 3-month LIBOR.
Source: SNB Data Portal
conjunction with the SNBs interest floor had caused the Swiss Franc to also depreciate against
the dollar (Swiss National Bank, 2015b).
Implementation The SNB traditionally achieves its target range for the 3-month LIBOR
through open market operations using repurchase agreements. Prior to the introduction of neg-
ative rates the remuneration of sight deposits was not part of its monetary policy framework,
which therefore had to be adjusted to allow for the policys implementation (Bech and Malkho-
zov, 2016). The negative rate applies only to the fraction of sight deposit holdings exceeding a
certain threshold. Different thresholds are calculated for each individual institution on the basis
of minimum reserve requirements if applicable, or as fixed thresholds for those institutions not
subject to reserve requirements. Where reserve requirements apply, the threshold is equal to a
static component (20 times the minimum reserve requirement prior to implementation), and a
dynamic component (minus any increase/plus any decrease in the amount of cash held) (Swiss
National Bank, 2015a). The latter aims to prevent institutions from hoarding cash to avoid the
negative interest rate (Bech and Malkhozov, 2016).
3.4 Central Bank of Sweden (Sveriges Riksbank)

The Sveriges Riksbank first implemented a negative interest rate when it cut its overnight
deposit rate (which is 75bp below the repo rate) to -25bp in July 2009 (Jorgensen and Risbjerg,
2012) (the rate stayed negative until September 2010). On 9 July 2014 the deposit rate was cut
to -50bp (Sveriges Riksbank, 2014b), and in February 2015 the repo rate first became negative
(Sveriges Riksbank, 2015a). On 18 March 2015, the Sveriges Riksbank announced its decision to
16
cut its repo rate to -25bp (Sveriges Riksbank, 2015b). The cut was accompanied by an expansion
of the Riksbanks asset purchase programme. Since February 2016 the repo rate stands at -50bp,
and the deposit rate at -125bp (Sveriges Riksbank, 2016a) (Figure 4).
Figure 4: Sveriges Riksbank, policy rates.
Source: Sveriges Riksbank
Context for implementing negative rates The decision of 18 March 2015 was made
with the aim to support the upturn in inflation and ensure that long-term inflation expecta-
tions are in line with the inflation target. (Sveriges Riksbank, 2015b) Inflation and economic
performance were increasing at the time, however inflation remained below its target of 2%, and
the kronor had begun to strengthen in the foreign exchange market (due in part to monetary
easing in the euro area and other parts of Europe). The Riksbank deemed this to be a poten-
tial threat to the upturn in inflation, and judged further monetary expansion to be necessary
(Sveriges Riksbank, 2015b).
Implementation The Riksbank generally does not impose minimum reserve requirements
on commercial banks. Banks therefore hold only very small amounts of funds in overnight
deposits; instead, funds are held as one-week debt-certificates which the Riksbank issues (and
purchases) at the repo rate (Bech and Malkhozov, 2016). Negative interest rates are imposed
within the usual operational framework, in which the interest rate corridor is formed by the
overnight lending rate (75bp above the repo rate), the repo rate, and the overnight deposit rate
(75bp below the repo rate) (Sveriges Riksbank, 2014a). There are no exemption thresholds.
17
3.5 Bank of Japan

On 29 January 2016, the Bank of Japan announced its decision to impose a negative interest rate
of -10bp on a fraction of commercial bank reserves, alongside the decision to continue its asset
purchase programme (Bank of Japan, 2016b). The interest rate applied to the complementary
deposit facility still stands at -10bp (Bank of Japan, 2017) (Figure 5).
Figure 5: Bank of Japan, main policy rate.
Context for implementing negative rates The Japanese economy entered a defla-
tionary trap in the 1990s, which persisted for almost two decades. The possibility of negative
nominal interest rate policy in Japan was discussed long before negative policy rates became a
reality (cf. Fukao, 2005). However, negative rates were introduced only after the economy had
begun to recover, and similar policies had already been tested in Europe.
The decision to introduce a negative policy rate was driven by the aim to safeguard Japans
recovery and ensure a continued increase in inflation (which was still below the target of 2%)
amidst rising volatility in global financial markets, in particular the decrease in the price of
crude oil and the decline in Chinese stock prices (Bank of Japan, 2016a; Kuroda, 2016).
Implementation The Bank of Japan introduced a three-tier remuneration system on bank

reserves along with its negative nominal rate. The three tiers are the basic balance earning an
interest rate of 10bp; the macro add-on balance, to which an interest rate of 0% applies; and
the policy-rate balance or complementary deposit facility, which earns a negative interest rate
of -10bp. The basic balance corresponds to the average balance of banks current accounts prior
18
to the introduction of a negative rate. The macro add-on balance is made up by the amount of
minimum required reserves, along with funds accumulated through the BoJs provision of credit
through the Loan Support Program and the Funds-Supplying Operation to Support Financial
Institutions in Disaster Areas affected by the Great East Japan Earthquake. It also includes
a balance calculated as a certain ratio of the amount outstanding of its basic balance (macro
add-on) at an appropriate time in the future to take account of the fact that the continued asset
purchase program would lead to a further accumulation of reserves. The policy-rate balance, to
which the negative interest rate applies, corresponds to any further outstanding balances (Bank
of Japan, 2016a).
3.6 National Bank of Hungary (Magyar Nemzeti Bank)

Hungarys central bank (MNB) announced on 22 March 2016 that it had to decided to cut its
overnight deposit rate to -5bp (Magyar Nemzeti Bank, 2016b).
Context for implementing negative rates The MNB targets an inflation rate of 3%.
Although the economy was growing, inflation decreased in February 2016 compared to the
previous month. The MNB judged that there remained a degree of unused capacity in the
economy, and that the economic environment displayed disinflationary tendencies. Projections
suggested that without further expansionary policy the 3% target might not be reached until
2018 (Magyar Nemzeti Bank, 2016b). The euro areas monetary easing and resulting pressure
on the Hungarian forint exchange rate likely also fed into the decision (cf. Jobst and Lin, 2016).
Implementation Since September 2015, the MNB maintains an asymmetric interest rate
corridor. The key policy rate is its base rate: the rate on three-month deposits with the MNB.
In March 2016, the base rate was cut from 210bp to 145bp; the rate on overnight collateralised
loans went from 135bp to 120bp; and the overnight deposit rate, which forms the corridors
lower bound, was reduced from +10bp to -5bp. (Magyar Nemzeti Bank, 2016b)
In October 2016, the MNB imposed quantitative limits on banks access to the three-month
deposit facility (Magyar Nemzeti Bank, 2016a). The following November, the rate on overnight
collateralised loans was set equal to the base rate; both stand at 90bp.
3.7 Bank of Norway (Norges Bank)

Norges Bank cut its reserve rate from 0% to -25bp on 25 September 2015. On 18 March 2016,
it was cut further to its current level of -50bp.
Context for implementing negative rates Norges Bank announced its decision to cut
its key policy rate, the rate on sight deposits, down to 75bp in September 2015. The reserve
rate became negative, as it is set at 1% below the rate on sight deposits. While Norges Bank
has not made its sight deposit rate, which is the main instrument determining interbank rates,
negative, it has indicated that it may decide to do so in the future. The decision followed earlier
rate cuts and was mainly motivated by a weaker outlook for economic growth due to the fall
19
in oil prices the previous summer, and an increase in unemployment. Other factors included
extremely low policy rates in other countries, and low wage growth keeping down cost inflation.
Norges Bank targets an inflation rate of 2.5% (Norges Bank, 2015a).
Implementation Norges Banks interest rate corridor is formed by the overnight lending
rate at the upper end (currently at 150bp), the reserve rate at the lower end (currently -50bp),
and the sight deposit rate (currently 50bp), which is usually followed closely by the overnight
interbank lending rate. Bank reserves earn the sight deposit rate up to a set quota, above which
the reserve rate applies. The overnight interbank rate is expected to remain close to the sight
deposit rate despite the negative reserve rate, as long as bank deposits remain below the quota
(Norges Bank, 2015b).
3.8 Further remarks

The above discussion has shown that in a number of cases, the choice to impose a negative
policy rate was driven in full or part by the need to maintain a stable exchange rate and prevent
the over-valuation of local currency. Small open economies in Europe, such as Switzerland or
Denmark, have little ability to set interest rates independently from the ECB. In such countries,
monetary policy operates primarily through the exchange rate channel: a depreciation in local
currency stimulates economic activity by boosting exports, and inflation by raising the price of
imports (cf. Jordan, 2016).
The central banks of Bosnia and Herzegovina and Bulgaria both maintain a fixed exchange
rate with the euro and set interest rates aiming to transmit the ECBs monetary policy stance.
In July 2016, the deposit rate in Bosnia and Herzegovina was cut to -20bp (50% of the ECBs
deposit facility); in Bulgaria, the deposit rate became negative in January 2016 (-30bp, equal to
the ECBs rate) and was lowered again to -40bp, again following the ECB (Jobst and Lin, 2016).4
Notably, none of the central banks in question used any of the mechanisms for eliminating the
lower bound which were discussed in the previous section. Most used the same policy frameworks
as before, albeit with slight changes such as the introduction of exemption thresholds or tiered
remuneration systems. The fact that no fundamental changes were required suggests that the
effective lower bound on nominal rates is located below zero, and has not yet been reached. The
following section will discuss the effects of negative nominal interest rates.
4
These two central banks have not been covered in detail because their policy rates follow that of the ECB so
closely.
20
4 Effects, dangers and risks

This section outlines how the policy decisions previously described have been transmitted to
financial markets and the real economy.5 It also discusses the limitations of the empirical
analysis presented. The discussion then moves on to potential risks posed by negative policy
rates, and their suitability as economic stimulus.
4.1 Empirical effects
Jurisdiction Objective Date Negative Rate Effects

(initial, lowest
and current level
(if different))
European Central Stimulating 11 June 2014 Deposit facility Higher inflation
Bank (Eurozone) inflation and (-0.1%, -0.4%) and growth, but
growth still below target
Danmarks Maintaining a 6 July 2012 Certificates of Positive growth,
Nationalbank stable foreign deposit (-0.2%, lower inflation,
(Denmark) exchange rate -0.75%, -0.65%) exchange rate
somewhat
stabilised
Schweizerische Maintaining a 15 January 2015 Sight deposits Mixed effect on
Nationalbank stable foreign (-0.75%) growth and
(Switzerland) exchange rate inflation,
exchange rate
stabilised
Sveriges Supporting 8 July 2009 Overnight Positive growth,
Riksbank upturn in Deposits higher inflation,
(Sweden) inflation, (-0.25%, -1.25%), stable exchange
maintaining a Repo rate rate
stable foreign (-0.1%, -0.5%)
exchange rate
Bank of Japan Safeguarding 29 January 2016 Complementary Apparent upturn
(Japan) recovery and deposit facility in growth and
upturn in (-0.1%) inflation6
inflation
Table 1: Overview of sections 3 and 4.1
European Central Bank
Transmission to financial markets The negative deposit rate fed through to money and
bond market rates normally. The overnight lending rate EONIA and the 3-month EURIBOR
became negative in late 2014 (Figure 6). Sovereign bond yields at maturities up to 10 years fell
below zero between late 2014 and early 2015. The yield curve flattened, although yield spreads
5
The central banks of Hungary and Norway will not be analysed here because their negative rates do not apply
to any substantive amount of reserves.
6
No strong conclusions can be drawn due to insufficient availability of data.
21
became quite volatile and increased again slightly after a sharp fall in early 2015 (Figure 7).
The cost of borrowing to the private sector decreased, although the impact on business vol-
ume was mixed. The volume of loans to households increased moderately, whereas the volume
of loans to firms, which had been falling since 2011, merely stabilised (Figures 8, 9, 10). Figure
11 illustrates the slight increase in new private sector loans since mid-2014, which was mainly
driven by lending to households. Adjusted loans to the private sector overall are currently grow-
ing at an annual rate which fluctuates around 2% (European Central Bank, 2016c). Average
interest on deposits for both households and non-financial corporations fell, with rates on sight
deposits approaching zero, but not becoming negative (Figure 12). This suggests that banks are
hesitant or unable to pass negative interest rates on to customers.
Presently there is no evidence of cash hoarding by banks as indicated by the value of currency
in circulation, which continued to increase broadly in line with its previous trend (Figure 13).
Broader effects Euro area inflation remained close to and even fell below zero in December
2014, a few months after the deposit rate became negative. It has picked up since mid-2016 and
risen to 1% (Figure 14). Real GDP grew by about 3.5% in the two years after the ECB first
introduced negative policy rates (Figure 15).
Danmarks Nationalbank
Transmission to financial markets As in the euro area, negative rates fed through
to financial markets normally. Interbank rates became negative in January 2015 (Figure 16).
Government bond yields fell and became negative for some maturities, but started to increase
again slightly in late 2016 (Figure 17). While the cost of borrowing for households and firms
decreased, the volume of borrowing did not show a significant increase (Figures 18, 19, 20).
Notably, interest on some wholesale deposits fell below zero, and average rates on short-term
deposits by households became negative for statistics including repos (Figures 21, 22). There
has been no unusual increase in the amount of currency in circulation (Figure 23).
The exchange rate with the euro fluctuated between 744 and 747 kroner per 100 euro after
negative rates were introduced, however since mid-2016 the kroner has appreciated once again.
The exchange rate has stayed between 743 and 744 kroner per 100 euro since the beginning of
this year (Figure 24).
Broader effects Real gross domestic product has persistently grown at annual rates of
0.9-1.7% since 2012 and growth appears to have quickened since the introduction of negative
nominal interest rate policy (Figure 25). Inflation displayed a continuous decrease over the same
period, and is now close to 0% (Figure 26).
22
Schweizerische Nationalbank
Transmission to financial markets The 3-month LIBOR stayed within the SNBs target
range and fell into negative territory in December 2014 (Figure 3), followed by other interbank
rates such as the SARON (Figure 27). Government bond yields also became negative at various
maturities at the end of the year (Figure 28). Comparing yield curves for government bonds
in January 2008, 2011 and 2017 (Figure 29) shows that the yield curve has changed: in 2011,
it assumed a normal, monotonous shape. In January 2017, yields for bonds of 2 or 3 years
maturity were lower than the yield on 1 year bonds, as was the case during the financial crisis.
The curve has also flattened. This suggests that interest rates are expected to go even lower
over the next few years, and stay low for a substantial period.
Since late 2014, lending rates to household and firms have not displayed a downward trend
(Figures 30, 31, 32). Interest on mortgages with variable interest rates even increased since
negative rates were introduced, and rates on investment and mortgage loans with fixed rates
fluctuated around approximately the same level and occasionally rose. This may reflect an at-
tempt by banks to pass the cost of paying the negative interest on to customers. However, the
volume of corporate loans as well as total credit volume have increased steadily since 2010 (Fig-
ures 33, 34), which suggests that sufficiently high demand for loans may be part of the reason
banks are able and inclined to charge higher rates.
Interest on sight and savings deposits with banks has been falling since 2009, but fell slightly
more sharply in early 2015 and is now close to 0%. Average interest on time deposits even
became negative at some low maturities (Figure 35). Nonetheless the growth of currency in
circulation appears stable (Figure 36). The exchange rate with the euro has been relatively
stable since early 2015 (Figure 37).
Broader effects Annual GDP growth fluctuated at around 2% between early 2013 and
2014, but then fell to less than 1% by early 2015 and has since fluctuated between 1-2% (Figure
38). Inflation continued to fall in early 2015 after the introduction of negative rates, and even
became negative, recovering only in late 2016 (Figure 39).
Sveriges Riksbank
Transmission to financial markets The STIBOR continued to follow the Riksbanks

repo rate closely. Over the past five years, the spread between the overnight rate and medium-
term interbank rates has narrowed noticeably (Figure 40). Yields on treasury bills and short-
term government bonds have become negative. Yields on longer-term government bonds have
been slightly more volatile, fluctuating just above zero between May 2015 and 2016, falling in
mid-2016 (those of 7 years or shorter maturity even below zero) and then rising again in late
2016 (Figures 41, 42).
23
Lending rates to households and non-financial corporations had fallen steadily since 2012,
but stabilised at around 2% and 1.5%, respectively, in late 2015. Credit volumes increased
steadily for the past 10 years (Figures 43, 44). Interest on bank deposits held by households
and non-financial corporations stayed at around 0% during the same period (Figure 45). This
suggests that banks are unwilling to pass increasingly negative rates on to their customers. The
total value of currency in circulation has been decreasing for a number of years, supporting the
claim that Sweden is transitioning to a cashless society (Figure 46). The exchange rate with the
euro has been relatively stable since the repo rate became negative (Figure 47).
Broader effects Gross domestic product has remained on a sustained growth path since
2012 (Figure 48). Inflation weakened in 2012, but has been rising since early 2015 and is now
just below 2%, suggesting that negative interest rates may have had the desired effect (Figure
49).
Bank of Japan
Transmission to financial markets Interbank lending rates fell below zero in early 2016
(Figure 50), as did yields on 10-year government bonds (Figure 51).7 The latter rose slightly
above zero again the following November. Bank lending rates have been decreasing since the
global financial crisis and showed no unusual trend after the introduction of negative nominal
interest rate policy. Lending volumes continued to increase broadly at the same rate as before
(Figure 52). Average interest on bank sight deposits decreased from 0.025% to 0% in early 2016
and has since remained at the same level (Figure 53). There has been no unusual trend in the
increase of currency in circulation (Figure 54). Since the introduction of negative nominal rates
the exchange rate has remained between 100 and 120 yen per US dollar (Figure 55).
Broader effects Quarter-to-quarter GDP growth has been volatile for many years. No
conclusions can be drawn for the purpose of this discussion, as data is only available up until
April 2016 (Figure 56). Inflation had been recovering since 2013, decreased slightly from late
2015 onwards, and showed a renewed increase in late 2016 (Figure 57).
4.2 Discussion and limitations of empirical evidence on the lower bound

The above analysis demonstrates that the effects of negative nominal interest rates were mixed,
differing between jurisdictions.
Generally, the effects on financial markets in terms of interbank lending rates and bond yields
were the same as those of conventional interest rate policy. Effects on average retail deposit and
lending rates were more varied. In the euro area, Sweden and Japan, interest on bank deposits
has not become negative and may be constrained at zero. Evidence from the euro area suggests
a proportion of banks who are reluctant to charge negative interest rates as such compensate
by increasing non-interest rate charges to customers (cf. European Central Bank, 2016a,b). In
7
Data on yields at other maturities was unavailable.
24
Denmark, average wholesale deposit rates became negative at times, as did average rates on
time deposits in Switzerland at some maturities.
The cost of borrowing to retail customers decreased in some jurisdictions, but not all; in
Switzerland, rates even increased. This may be a perverse effect of negative interest rate policy
and be symptomatic of the policys impact on bank profitability (cf. Jordan, 2016). There ap-
pear to have been modest, if any, increases in the volume of borrowing in response to decreasing
borrowing costs.
Growth rates of currency in circulation do not indicate that cash hoarding has occurred in any
area analysed, suggesting that the physical lower bound on nominal interest rates has not been
hit. In Sweden, the amount of currency in circulation even decreased, continuing an existing
trend. Effects on inflation and growth are also mixed. Economic growth has mostly shown
positive developments, except in Switzerland, where it decreased overall after 2014. Inflation
picked up in the euro area and to some extent in Switzerland only in 2016, and continued to fall
in Denmark; a sustained rise in inflation is present only in Sweden. Since the Bank of Japan only
introduced negative rates in 2016, the policy seems to have had the intended effect on inflation
up until now. However, any conclusions on this are premature. Exchange rates mostly stabilised
where that was the intention.
Limitations The effects of negative interest rates are difficult to identify. Data is insufficient
for time series regression analysis because the policies were only recently introduced. Descrip-
tive analysis shows the trends identified above, but determining the extent to which these are a
result of negative interest rate policy is particularly difficult because the policy was usually im-
plemented in conjunction with asset purchase programmes. The surprising emergence of rising
lending rates charged by Swiss banks to retail customers may be an adverse effect of negative
policy rates, but may also be due to other factors.
It is hard to say what would have happened, had negative nominal interest rates not been im-
posed. Even where inflation and growth are still below desired levels, they might have performed
significantly worse in the policys absence (cf. Praet, 2016; Jordan, 2016).
Effective/physical and economic lower bound Evidence shows that the effective lower
bound on interest rates appears to be below zero - no cash hoarding has occurred so far. How-
ever, substituting for paper currency may become profitable if rates stay this low or become
even lower. The mechanisms discussed in section 2 could be utilised to reduce the effective lower
bound further.
Even if rates can become substantially more negative, it is possible that the effects eventually
reverse, due to a negative impact on bank profitability which may worsen, rather than ease,
lending conditions. This has been referred to as the economic lower bound or reversal rate:
a point at which lowering policy rates no longer has the effect of easing monetary conditions, or
leads to the opposite result (cf. Brunnermeier and Koby, forthcoming).
25
4.3 Dangers and risks

There are a number of potential risks associated with negative nominal interest rate policy, each
of which will be discussed in turn.
While negative real interest rates are a normal part of economic life, negative nominal rates
may be perceived as unnatural (cf. Coeure, 2016). This is because the public typically exhibits
money illusion: a tendency to think in nominal, rather than real, terms (cf. Shafir et al., 1997).
This is unlikely to matter in cases where negative nominal rates are experienced directly only
by banks, but may result in confusion and a loss of trust if and when negative rates are passed
on to retail customers.
The danger which has received most attention in the academic literature is the potential
decision by economic actors to substitute deposits for paper currency. The interest rate at
which such a decision becomes profitable is determined by the cost of holding large amounts
of cash, and is likely below zero. This is referred to as the physical or effective lower bound
on interest rates and has been discussed at length in previous sections. Substituting for paper
currency would make transactions significantly more costly and would lead to dis-intermediation
if members of the public were to withdraw their deposits (cf. Coeure, 2016). This would imply
significant economic costs.
Section 4.2 touched upon the possibility that aside from the physical lower bound there may
be an economic lower bound or reversal rate: a point at which accommodating monetary
policy no longer has its desired effect, and below which its effects are reversed (cf. Brunnermeier
and Koby, forthcoming; Coeure, 2016). A substantial proportion of banks income is derived
from interest margins, which are affected by both the level and shape of the yield curve. The
level of interest rates faced by banks may narrow their margins if it is very low and they are
reluctant or unable to lower deposit rates sufficiently, for example because the latter are bounded
at zero. Institutions could avoid such losses by not passing on lower interest rates to their bor-
rowers, or by increasing non-interest charges on borrowers, which would at least partially defeat
the purpose of the policy. In a scenario in which persistently low or negative rates are passed
on to borrowers, but not depositors or other lenders, banks profits would be diminished. A
flattened yield curve resulting from an expectation of persistent low or negative rates reduces
intermediaries interest income derived from the difference in maturity between their assets and
liabilities.
Borio et al (2015) find that these effects of monetary policy on banks profitability are sub-
stantial at low interest rates, and outweigh potential positive effects on profitability (for example
through decreased loan loss provisions or increased securities valuations). Responses to the euro
area bank lending survey in 2016 (European Central Bank, 2016a,b) indicate that banks have
seen a decline in their interest income as a result of the ECBs negative deposit facility rate.
The increase in some lending rates by Swiss banks may be an attempt to offset the decline in
interest margins resulting from the SNBs negative interest rate policy; however, as the SNBs
26
monetary policy operates mainly via the exchange rate channel, this may not be an issue in this
case (Jordan, 2016).
Persistently low or negative rates also have implications for non-bank financial institutions,
particularly those with fixed long-term liabilities and a requirement to invest in safe assets, such
as pension funds and insurance companies. Such institutions may find it increasingly difficult to
finance themselves (Praet, 2015; Davies, 2016), which may compromise their customers future
economic security and thereby impact negatively on consumption. A related issue is the danger
that instead of substituting consumption or investment for saving, economic agents may attempt
to offset the diminished or potentially negative return on their savings by saving more to achieve
a certain goal. However, evidence suggests that on average, substitution effects towards con-
sumption tend to offset negative income effects experienced by savers: overall, a redistribution
from lenders to borrowers occurs, and the latter have a higher marginal propensity to spend
(Coeure, 2016).
Another concern is that negative interest rate policy may compromise financial stability.
Firstly, a low or negative return on safe assets is expected to induce higher risk-taking by
investors. This is, to an extent, the intention of accommodating monetary policy. However,
risk-taking may become excessive and lead to instability. Furthermore, any reductions in banks
profitability will potentially make it harder for the latter to raise equity capital (cf. Coeure,
2016). This may hamper attempts to raise capital in response to new regulations such as those
introduced by the Basel III Accord.
4.4 Effectiveness of negative nominal interest rates and policy alternatives

Much of the importance attributed to the lower bound on interest rates as a constraint on eco-
nomic policy is based on the idea that interest rates must be brought in line with the natural
rate of interest in order to be consistent with full employment and potential output - or below
it, if the policy is to be expansionary and inflationary. From this perspective, negative nominal
interest rate policy may well be necessary. Leaving aside the matter of whether there is such a
thing as a unique, supply-determined natural rate of interest, too high a level of real interest
rates is undoubtedly counter-productive in a stagnant economic environment.
However, in the current political environment appropriate monetary policy is far from being
viewed as a mere necessity for economic recovery. Rather, it frequently finds itself as the only
policy tool viewed as acceptable, as fiscal expansion is deemed undesirable not least due to its
role in increasing public debt (G30 Working Group, 2015).
The above discussion has shown that while negative nominal interest rates may have averted
worse economic outcomes, inflation and growth remain below target in most jurisdictions in
which negative nominal interest rates have been deployed. While there is some evidence that
lending conditions for firms and households have improved (cf. European Central Bank, 2016a,b),
the impact of eased lending conditions is bound to be limited in a stagnant economic environ-
27
ment. Lending conditions are only one factor in determining investment decisions, and are
unlikely to compensate for a lack in aggregate demand and low expected profitability. Other
policy measures may be required to successfully address secular stagnation. As was fittingly put
by Peter Praet, member of the Executive Board of the ECB:
[M]onetary policy is only a necessary condition for normalisation; it is not a suffi-

cient one. (Praet, 2015)
28
5 Conclusion
In the aftermath of the 2008 crisis and a context of secular stagnation, central banks in several
advanced economies reached the limits of conventional interest rate policy, with rates at or near
zero. To provide further stimulus, balance sheet policies in the form of large-scale asset pur-
chase programmes were introduced. Since 2014, the central banks of the Eurozone, Denmark,
Switzerland, Sweden and Japan, and to some extent Hungary and Norway, have also breached
what was previously thought of as the lower bound on nominal interest rates and lowered policy
rates below zero.
This dissertation has explored the issue of a lower bound on nominal interest rates from
both a theoretical and an empirical perspective. There are three main proposals put forward
to eliminate the lower bound by abolishing the role of paper currency as an interest-free, liquid
and safe store of value: abolishing paper currency, taxing it, and decoupling it from the unit of
account. None of these proposals have been implemented in practice, although Sweden is seen
as being in transition to a cashless economy. The success of implementing any such proposal
depends on the cultural and economic context in which it is implemented.
The rationale for introducing negative nominal policy rates differed between jurisdictions.
In the euro area, Sweden, Hungary, Norway and Japan, the aim was to stimulate growth and
inflation. In Denmark and Switzerland, negative rates were primarily a reaction to the negative
interest rate policy of the ECB, which put considerable appreciation pressures on the Swiss franc
and Danish kroner (as well as other European currencies). Negative rates were quite success-
ful in stabilising exchange rates, while effects on growth and inflation were moderate at best.
Given that no cash hoarding has occurred, and that the policys effect on lending volumes and
economic activity was modest even where it was transmitted successfully in the form of more
favourable borrowing conditions, it seems unlikely that the use of any of the proposals outlined
in section 2 would have enhanced the policys effectiveness.
Negative nominal rates are associated with a number of risks. While there are significant
costs associated with storing large amounts of paper currency, making the effective lower bound
negative, cash hoarding may occur if rates become considerably more negative and are expected
to stay that way for an extended period of time. Persistently low or negative rates impact
negatively on the profitability of banks and other financial institutions. At a certain point,
further monetary easing may result in worsened, rather than improved, lending conditions. This
is referred to as the economic lower bound or reversal rate.8 Negative rates may furthermore
compromise financial stability through excessive risk-taking. While the lower bound on interest
rates appears to be below zero, and there may be ways of lowering it even further once it has
been hit, the desirability of doing so is therefore questionable.
8
The literature would benefit from a comprehensive review of how banks funding structures have changed in
response to negative nominal rates.
29
Negative nominal interest rate policy may have been successful in easing monetary conditions
and preventing even lower levels of growth and inflation. However, in most of the jurisdictions
discussed it has not been sufficient to return them to their desired levels. Monetary stimulus
cannot be solely relied upon in addressing secular stagnation.
30
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Appendices
A European Central Bank
Figure 6: Euro area, interbank rates.
35
Figure 7: Euro area, government bond yields.
Figure 8: Euro area, borrowing conditions and volume for non-financial corporations.
Sources: ECB Statistical Data Warehouse, Thomson Reuters
36
Figure 9: Euro area, borrowing conditions and volume for households and non-profit institutions
serving households (all purposes).
Figure 10: Euro area, borrowing conditions and volume for house purchase.
37
Figure 11: Euro area, volume of new private sector loans.
Figure 12: Euro area, annualised agreed rate on overnight deposits and deposits with agreed
maturity (over 2 years original maturity), new business coverage.
38
Figure 13: Euro area, currency in circulation.
Figure 14: Euro area, inflation.
39
Figure 15: Euro area, GDP at 2010 prices.
Source: Eurostat
B Danmarks Nationalbank
Figure 16: Denmark, interbank rates.
40
Figure 17: Denmark, bond yields.
Source: DN Statbank
Figure 18: Denmark, borrowing conditions and volume for non-financial corporations.
Source: DN Statbank
41
Figure 19: Denmark, borrowing conditions and volume for households (all purposes).
Source: DN Statbank
Figure 20: Denmark, borrowing conditions and volume for house purchase.
Source: DN Statbank
42
Figure 21: Denmark, annualised agreed rate on deposits with agreed maturity and repos by
non-financial corporations in the MFI sector.
Source: DN Statbank
Figure 22: Denmark, annualised agreed rate on deposits with agreed maturity and repos by
households in the MFI sector.
Source: DN Statbank
43
Figure 23: Denmark, currency in circulation.
Figure 24: Euro to DKK exchange rate.
Source: DN Statbank
44
Figure 25: Denmark, GDP at 2010 prices.
Source: Statistics Denmark
Figure 26: Denmark, inflation.
Source: Statistics Denmark
45
C Schweizerische Nationalbank
Figure 27: Switzerland, interbank rates.
Figure 28: Switzerland, government bond yields.
46
Figure 29: Switzerland, yield curve.
Figure 30: Switzerland, interest on investment loans.
47
Figure 31: Switzerland, interest on fixed-rate mortgages.
Figure 32: Switzerland, interest on variable-rate mortgages.
48
Figure 33: Switzerland, volume of corporate loans.
Figure 34: Switzerland, total credit volume.
49
Figure 35: Switzerland, interest on bank deposits.
50
Figure 36: Switzerland, currency in circulation.
Figure 37: Euro to CHF exchange rate.
51
Figure 38: Switzerland, change in GDP at previous years prices.
Figure 39: Switzerland, inflation.
52
D Sveriges Riksbank
Figure 40: Sweden, interbank rates.
Figure 41: Sweden, treasury bill yields.
53
Figure 42: Sweden, government bond yields.
Figure 43: Sweden, cost and volume of borrowing by non-financial corporations.
Source: Statistics Sweden
54
Figure 44: Sweden, cost and volume of borrowing by households.
Figure 45: Sweden, interest on bank deposits.
55
Figure 46: Sweden, currency in circulation.
Figure 47: Euro to SEK exchange rate.
56
Figure 48: Sweden, change in GDP per capita (denominated in EUR).
Source: Eurostat
Figure 49: Sweden, inflation.
57
E Bank of Japan
Figure 50: Japan, interbank rates.
Sources: Bank of Japan, Thomson Reuters
Figure 51: Japan, government bond yields.
58
Figure 52: Japan, cost and volume of borrowing by the private sector.
Figure 53: Japan, interest on bank deposits.
Source: Bank of Japan
59
Figure 54: Japan, currency in circulation.
Figure 55: US dollar to yen exchange rate.
60
Figure 56: Japan, real GDP, annualised rate of change.
Figure 57: Japan, inflation.
61

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Negative Nominal Interest Rate Policy - Motivations Implementation and Risks Pia-Katharina Andres

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Negative nominal interest rate policy: motivations,

implementation and risks

Expansionary monetary policy was traditionally thought to be restricted by the zero

2 The lower bound on nominal interest rates and ways to overcome it 7

3 How central banks have implemented negative nominal policy rates 13

4 Effects, dangers and risks 21

A European Central Bank 35

38 Switzerland, change in GDP at previous years prices. . . . . . . . . . . . . . . . 52

2 The lower bound on nominal interest rates and ways to over-

If the costs of holding money can be neglected, it will always be profitable to

2.2 The lower bound on interest rates as a policy constraint

2.3 Abolishing paper currency

be discussed further in section 2.6.

2.4 Taxing paper currency

2.5 Decoupling paper currency from the unit of account

2.6 Further proposals and considerations

other words, the public is likely to exhibit money illusion.

3 How central banks have implemented negative nominal policy

3.1 European Central Bank

Figure 1: European Central Bank, policy rates.

Source: ECB Statistical Data Warehouse

3.2 Denmarks National Bank (Danmarks Nationalbank)

Figure 2: Danmarks Nationalbank, policy rates.

Source: Thomson Reuters

Implementation In Denmark, commercial banks current account holdings earn a current

3.3 Swiss National Bank (Schweizerische Nationalbank)

Figure 3: Schweizerische Nationalbank, target range and 3-month LIBOR.

Source: SNB Data Portal

3.4 Central Bank of Sweden (Sveriges Riksbank)

Figure 4: Sveriges Riksbank, policy rates.

Source: Sveriges Riksbank

3.5 Bank of Japan

Figure 5: Bank of Japan, main policy rate.

Source: Thomson Reuters

Implementation The Bank of Japan introduced a three-tier remuneration system on bank

3.6 National Bank of Hungary (Magyar Nemzeti Bank)

3.7 Bank of Norway (Norges Bank)

3.8 Further remarks

4 Effects, dangers and risks

4.1 Empirical effects

Jurisdiction Objective Date Negative Rate Effects

Table 1: Overview of sections 3 and 4.1

European Central Bank

Transmission to financial markets The STIBOR continued to follow the Riksbanks

4.2 Discussion and limitations of empirical evidence on the lower bound

4.3 Dangers and risks

4.4 Effectiveness of negative nominal interest rates and policy alternatives

[M]onetary policy is only a necessary condition for normalisation; it is not a suffi-

(2017): Statement on Monetary Policy, Statement by the Bank of Japan, 31 January

Borio, C. and P. Disyatat (2009): Unconventional monetary policies: an appraisal, BIS

Brunnermeier, M. K. and Y. Koby (forthcoming): The Reversal Interest Rate: An Ef-

Fisher, I. (1933): Stamp Scrip, New York: Adelphi.

Fremmich Andresen, M., M. Strom Kristoffersen, and L. Risbjerg (2015): The

Jorgensen, A. and L. Risbjerg (2012): Negative Interest Rates, Danmarks Nationalbank

Kimball, M. (2013): A Minimalist Implementation of Electronic Money, Confessions of a

(2015): Negative Interest Rate Policy as Conventional Monetary Policy, National

Kuroda, H. (2016): Re-anchoring inflation expectations via Quantitative and qualitative

Neate, R. (2016): US Federal Reserve raises interest rates for second

Powell, B. (2012): The Law Of Unintended Consequences: Geor-

(2016): Transmission channels of monetary policy in the current environment, Keynote

Rogoff, K. (2016): The Curse of Cash, Princeton: Princeton University Press.

Strupp, J. (2012): Alabama Illegal Immigrant Crackdown Destroys Farm Business,

A European Central Bank