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Negative nominal interest rates and monetary policy

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  • Kim, Duhyeong

Abstract

How much can central banks reduce nominal interest rates? Can the lower bound be controlled by monetary policy? If so, should central banks reduce it to implement negative interest rates? I construct a model with multiple means of payment where the costs of holding paper currency effectively reduce its rate of return, creating a negative effective lower bound on interest rates. I find that central banks can reduce this lower bound with a non-par exchange rate between currency and bank reserves, but doing so raises currency-holding costs for individuals, leading to welfare losses. Moreover, implementing a negative rate by reducing the lower bound has no benefits because this policy combination lowers both the rate of return on currency and the interest rate on financial assets, leaving relative interest rates unchanged.

Suggested Citation

  • Kim, Duhyeong, 2025. "Negative nominal interest rates and monetary policy," Journal of Monetary Economics, Elsevier, vol. 154(C).
    • Handle: RePEc:eee:moneco:v:154:y:2025:i:c:s0304393225000704
    DOI: 10.1016/j.jmoneco.2025.103799
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    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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