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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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    1. Gara Afonso & Ricardo Lagos, 2015. "Trade Dynamics in the Market for Federal Funds," Econometrica, Econometric Society, vol. 83, pages 263-313, January.
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    3. Todd Keister & James J. McAndrews, 2009. "Why are banks holding so many excess reserves?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Dec).
    4. Benjamin Lester & Roc Armenter, 2015. "Excess Reserves and Monetary Policy Normalization," 2015 Meeting Papers 586, Society for Economic Dynamics.
    5. Martin, Antoine & McAndrews, James J. & Palida, Ali & Skeie, David R., 2013. "Federal Reserve tools for managing rates and reserves," Staff Reports 642, Federal Reserve Bank of New York, revised 01 Apr 2019.
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    7. Ruchir Agarwal & Miles Kimball, 2015. "Breaking Through the Zero Lower Bound," IMF Working Papers 15/224, International Monetary Fund.
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    9. William Poole, 1968. "Commercial Bank Reserve Management In A Stochastic Model: Implications For Monetary Policy," Journal of Finance, American Finance Association, vol. 23(5), pages 769-791, December.
    10. Elizabeth C. Klee & Zeynep Senyuz & Emre Yoldas, 2016. "Effects of Changing Monetary and Regulatory Policy on Overnight Money Markets," Finance and Economics Discussion Series 2016-084, Board of Governors of the Federal Reserve System (US).
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    Cited by:

    1. Bech, Morten & Keister, Todd, 2017. "Liquidity regulation and the implementation of monetary policy," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 64-77.

    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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