Question

how negative interest rates affect different monetary balance sheet channel, i.e., the channels through which central bank actions have an effect on financial markets and the economy.

Explain the transmission channel and particularly how it operates in a negative interest rate environment. In particular, you should address these four questions:

1. Explain as clear as possible how the channel works in normal circumstances

2. What changes in a negative interest rate environment, and why?

3. Give a reason why it could become more effective

4. Give a reason why it could become less effective

You could keep it conceptual, or apply it to a specific case, like the situation in the Euro area or another country with a negative interest rate, like Switzerland

Answer 1

A Central Bank applies Negative Interest rate as a monetary policy action to propel or boost the slowing economy of the nation. It is used as one of the last resort measures for the aforesaid result when the other conventional and tested actions are not working. In this, a Central Bank charges its banks on depositing money to it. The central bank expects by this move in a normal circumstances, that citizens will deposit less in the bank and, instead, will spend it on commodities or bigger purchases. Eventually, the consumption increases, industries profit and expand, and create jobs. Thus, creating demand ,and the economy may come out of slowdown as a spiral effect. It was used by the central bank of Sweden's in 2009 by lowering its overnight deposit rate to -0.25% to cater to propel the overall economy.

During the negative rate environment, the profits of banks squeezes as deposits are lessen and the lending, effectively, is less profiting. The yields on government bonds become negative as they are not earning and are used to support nation's financial stake-holders.

As discussed earlier, this measure could be more effective because people will be discouraged to hold the cash with them or with a bank, and thus will think to and utilize it like consuming on products and / or services domestically.

This measure could backfire too. As economy slows down, the prices fall due to weakened demand. This encourages the deposit holders to withdraw more from the banks (to save from paying charges for deposits) and hold cash even more, in the wait of falling of the prices further. This is why, this action of central bank's could become less effective.

I’ve tried to answer the four questions with their solutions and their explanations describing the concept of the negative interest rate measure of a central bank as well as the historic scenario as an example. I really appreciate that you will write me a good review for the answer. And if you need anything else in future – do let me know.

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