Inflation rates have declined across the advanced economies in recent decades (Lane 2020). With concomitant secular declines in natural real interest rates (Williams 2015), nominal policy rates have been exceptionally low, constraining central banks’ monetary policy space. The situation has led some central banks to take the historical step of reducing short-term policy rates into negative territory. Figure 1 shows that Denmark, with an exchange rate peg to the euro, was the first country to cut rates into negative territory in 2012, following pressures in foreign exchange (FX) markets. The euro area, Sweden, Switzerland, and Japan soon followed suit. The experience has shown that zero is not the lower bound on policy rates. The existence of cash, however, implies that there is an effective lower bound (ELB) that has not yet been met.
Figure 1 Monetary policy interest rates in countries with NIRP
Source: Refinitiv Datastream.
Monetary policy in negative interest rate territory is referred to as negative interest rate policy (NIRP). NIRP has been controversial and raised questions about transmission and possible side effects. For example, concerns have been voiced that if negative policy rates cannot be transmitted to bank deposits, they may constrain profitability and the willingness to extend credit in the banking sector. Some have suggested and presented evidence that the transmission to bank lending rates may break down or even reverse as policy rates drop into negative territory (Eggertsson and Summers 2019, Brunnermeier and Koby 2019). Others have argued that negative rates give rise to excessive risk taking and related financial stability concerns (e.g. Andersson and Jonung 2020).
At the same time, a number of studies have found that negative rates provide stimulus to the economy (Adolfsen and Spange 2020, Altavilla et al. 2019, Bottero et al. 2019, Demiralp et al. 2019, Eisenschmidt and Smets 2018). But the jury is still out on the pros and cons of NIRP, underlining the need for continued research and analysis – not least as the covid-19-related downturn reinforces the continued need for effective tools to achieve monetary policy stimulus (Lilley and Rogoff 2020).
In this column, we summarise some of the emerging evidence and contributions based on Danish data. In Denmark, monetary policy rates are set with the sole objective of maintaining a fixed exchange rate to the euro. Nevertheless, the lessons from Denmark are of relevance for inflation targeting central banks contemplating cuts in the policy rate into negative territory. Denmark has the longest experience of any country with negative policy rates. Moreover, the exceptional availability of micro data for banks and firms helps shed light on questions relating to the transmission of negative rates. This forms the basis for ongoing studies conducted in Danmarks Nationalbank. Emerging conclusions can be summarised as follows.
First, the exchange rate channel of monetary policy seems to work under NIRP.
In Denmark, where the monetary policy interest rate is set to secure the peg, the transmission of the policy rate to the foreign exchange market has not changed since the introduction of negative policy rates. Policy rate changes in negative territory are experienced as a direct extension of policy rate changes in normal times. This is suggestive of a well-functioning exchange rate channel of monetary policy transmission. There are also no signs that transmission through asset prices has changed since policy rates turned negative.
Second, there are no signs of the reversal rate in Denmark, as bank lending rates have declined in tandem with negative policy rates.
Panel A of Figure 2 shows that since the modest peak in August 2011, the total decline in banks’ average lending rates to firms and households has been almost equivalent to the concurrent decline in the policy rate. Adolfsen and Spange (2020) investigate the transmission of negative policy rate cuts to bank lending rates in a sample of Danish banks, exploiting the variation in the policy rate above and below zero. Panel B of Figure 2 shows that prior to the introduction of negative policy rates, a change in the key policy rate of one percentage point led to an average change in bank lending rates of approximately 70 basis points in the same direction within three months. The estimated pass-through over three months was cut in half after the introduction of negative rates, but it has remained clearly statistically significant and has not reversed direction. The lower estimate after the introduction of negative rates may to some extent reflect that pass-through has become slower, with more of the pass-through happening beyond the three months horizon.
Adolfsen and Spange (2020) also find that the transmission to bank lending rates has not been statistically different in banks that rely more heavily on deposit funding. Moreover, there are no indications that deposits as a share of total assets have affected lending growth. These findings run counter to the predictions of the reversal rate theory. In short, the transmission to bank lending rates, as well as bank credit, has worked qualitatively as in normal times in Denmark, but has come with some delay.
Figure 2 Bank lending rates and pass-through of changes in monetary policy rates
A) Trends in policy rate and lending rates
B) Pass-through of monetary policy, within three months
Note: Panel B shows pass-through from a 1 percentage point change in the rate of interest on certificates of deposits to bank lending rates within three months estimated on a panel of 23 large and medium-sized Danish banks in the period, January 2003 to January 2020 using bank fixed effects. ‘Overall’ is a weighted average of lending rates to households and non-financial firms. The chart illustrates point estimates and 95 percent confidence intervals. Source: Danmarks Nationalbank and Adolfsen and Spange (2020).
Third, negative policy rates increasingly transmit to bank deposit rates in Denmark.
In NIRP countries, banks have initially been hesitant to introduce negative interest rates on deposits from non-financial customers. This has been seen as a zero lower bound on bank deposits. But the Danish experience tells us that transmission to bank deposits can take place. Panel A in Figure 3 shows that changes in policy rates to some extent have been passed through to deposit rates for non-financial firms in Denmark, after policy rates turned negative. In Denmark, negative deposit rates are no longer an exotic phenomenon reserved for the largest corporations. Panel B of Figure 3 shows that in February 2020, three quarters of non-financial corporates’ deposits were subject to negative interest. The percentage is even higher for non-bank financial firms. Moreover, in late 2019, Danish banks started transmitting negative rates to household deposits above a certain size (Danmarks Nationalbank 2020b). The threshold for introducing negative interest rates has been gradually declining. In a number of banks, household deposits in excess of approximately €35,000 are now subject to a negative interest rate. In short, the response of bank deposit rates to negative policy rates is increasingly looking like normal monetary policy transmission in Denmark.
Figure 3 Deposit rates and distribution of deposit rates for non-financial corporations
A) Trends in policy rate and deposit rates
B) Prevalence of negative interest rates for non-financial corporations
Source: Danmarks Nationalbank.
Fourth, the data suggest that negative policy rates have helped boost employment and investment in Danish non-financial firms.
In a forthcoming paper from Danmarks Nationalbank, Kim Abildgren and Andreas Kuchler make use of micro data on non-financial firms’ balance sheets and operations, and link these with data on the firm’s bank connections. The data notably show whether or not the firm’s banks have imposed negative interest rates on their corporate deposits. Using an event study methodology and controlling for interest rate changes in general, they find that when the bank of a non-financial firm introduces negative rates on deposits, the firm increases both investment and employment as a response. The increase is statistically significant and substantial in size. The study also finds that firms that are affected by negative rates on their deposit holdings tend to reduce their liquidity as well as their leverage. While the transmission of negative policy rates to banks’ lending and deposit rates has been slower than when policy rates are positive, these results indicate a relatively strong transmission of NIRP to the real economy once banks cross the threshold and introduce negative interest rates on deposits.
Are negative rates a cause for financial stability concerns in Denmark?
Increased risk taking in response to cuts in the policy rate is a normal part of the monetary policy transmission mechanism. The concern is that increased risk taking becomes a threat to financial stability, and here, the jury is still out. We do see some indications of increased risk taking within certain segments of the Danish financial sector (Danmarks Nationalbank 2020a). Facing a prolonged low interest rate environment, some financial companies have intensified their search for yield, increasingly investing in alternative asset classes and relaxing credit conditions. Moreover, regional banks are increasingly reaching out to clients beyond their geographical areas, while larger banks have ventured abroad. The authorities have taken action to prevent these developments from turning into financial imbalances that could threaten the stability of the financial system.
The emergence of negative policy rates has raised questions about their economic and financial implications. The exceptional experience of Denmark with negative interest rates provides a good testing ground for these questions. The evidence suggests that the transmission of NIRP to bank lending and deposit rates, as well as credit, has worked qualitatively as in normal times, but has come with some delay. In addition, firms seem to boost investment and employment when they are exposed to negative interest rates on their deposit accounts, suggesting that the transmission of negative policy rates to the real economy remains in place.
Adolfsen, J F and M Spange (2020), “Modest pass-through of monetary policy to retail rates but no reversal”, Danmarks Nationalbank working paper no. 154.
Bottero, M, C Minoiu, J L Peydro, A Polo, A F Presbitero and E Sette (2019), “Negative Monetary Policy Rates and Portfolio Rebalancing: Evidence from Credit Register Data”, IMF Working Paper, 19/44.
Brunnermeier, M K and Y Koby (2019), “The Reversal Rate”.
Danmarks Nationalbank (2020a), “Credit institutions are facing hard times”, Financial Stability – 1st half 2020.
Danmarks Nationalbank (2020b), “Private deposits for kr. 34 billion at a negative rate”.
Demiralp, S, J Eisenschmidt and T Vlassopoulos (2019), “Negative interest rates, excess liquidity and retail deposits: banks’ reaction to unconventional monetary policy in the euro area”, ECB Working Paper Series, No. 2283.
Eisenschmidt, J and F Smets (2018), “Negative interest rates: Lessons from the euro area”, In A Aguirre, M Brunnermeier and D Saravia (eds.), Monetary policy and Financial stability: Transmission mechanisms and policy implications, Central Banking, Analysis, and Economic Policies Book Series, vol. 26, 2, Central Bank of Chile, pp. 13-42.
Lane, P R (2020), “International inflation co-movements”, speech given at the Inflation: Drivers and Dynamics 2020 Online Conference, Federal Reserve Bank of Cleveland/European Central Bank, 22 May.