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Monetary Policy Implementation in a Negative Rate Environment

Author

Listed:
  • Michael Boutros
  • Jonathan Witmer

Abstract

Monetary policy implementation could, in theory, be constrained by deeply negative rates since overnight market participants may have an incentive to invest in cash rather than lend to other participants. To understand the functioning of overnight markets in such an environment, we add the option to exchange central bank reserves for cash to the standard workhorse model of monetary policy implementation (Poole 1968). Importantly, we show that monetary policy is not constrained when just the deposit rate is below the yield on cash. However, it could be constrained when the target overnight rate is below the yield on cash. At this point, the overnight rate equals the yield on cash instead of the target rate. Modifications to the implementation framework, such as a tiered remuneration of central bank deposits contingent on cash withdrawals, can work to restore the implementation of monetary policy such that the overnight rate equals the target rate.

Suggested Citation

  • Michael Boutros & Jonathan Witmer, 2017. "Monetary Policy Implementation in a Negative Rate Environment," Staff Working Papers 17-25, Bank of Canada.
    • Handle: RePEc:bca:bocawp:17-25
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    References listed on IDEAS

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    7. Banerjee, Ryan N. & Mio, Hitoshi, 2018. "The impact of liquidity regulation on banks," Journal of Financial Intermediation, Elsevier, vol. 35(PB), pages 30-44.
    8. Ruchir Agarwal & Miles Kimball, 2015. "Breaking Through the Zero Lower Bound," IMF Working Papers 15/224, International Monetary Fund.
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    Citations

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    Cited by:

    1. Toshifumi Nakamura, 2020. "A simple model of interbank trading with tiered remuneration," Papers 2006.10946, arXiv.org.
    2. Fabio Canetg, 2020. "Monetary Policy Implementation and Pass-Through," Diskussionsschriften dp2004, Universitaet Bern, Departement Volkswirtschaft.
    3. Bech, Morten & Keister, Todd, 2017. "Liquidity regulation and the implementation of monetary policy," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 64-77.
    4. Alessandro Secchi, 2019. "A two-tier system for remunerating banks’ excess liquidity in the euro area: aims and possible side effects," Questioni di Economia e Finanza (Occasional Papers) 534, Bank of Italy, Economic Research and International Relations Area.
    5. Jonathan Witmer, 2020. "Monetary Policy Independence and the Strength of the Global Financial Cycle," Staff Working Papers 20-26, Bank of Canada.

    More about this item

    Keywords

    Interest rates; Monetary policy framework; Monetary policy implementation;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G - Financial Economics
    • G0 - Financial Economics - - General

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