Banks, Money, and the Zero Lower Bound on Deposit Rates

Abstract

We develop a New Keynesian model where all payments between agents require bank deposits through deposits-in-advance constraints, bank deposits are created through disbursement of bank loans, and banks face a convex lending cost. At the zero lower bound on deposit rates (ZLBD), changes in policy rates affect activity through both real interest rates and banks' net interest margins (NIM). At estimated credit supply elasticities, the Phillips curve is very flat at the ZLBD, because inflationary pressures increase NIM. This strongly increases credit and thereby output, but it dampens inflation by relaxing price setters' credit rationing constraint. At the ZLBD, monetary policy has far larger effects on output relative to inflation, and Taylor rules stabilize output less effectively than rules that also respond to credit. For post-COVID-19 policy, this suggests urgency in returning inflation to targets, avoidance of negative policy rates, and a strong influence of credit conditions on rate setting.

Bank business models, negative policy rates, and prudential regulation

“…Such a characterization does not completely support the retail deposits channel, which would imply less credit by banks with high deposits in a low-rate environment because of the net interest margin compression. According to this view, since retail banks are reluctant to pass negative rates onto depositors, negative policy rates may compress banks' profits and erode capital (Heider et al 2019;Eggertsson et al 2019;Kumhof and Wang 2020). Instead, we find that retail banks were not experienced a significant margin compression such as the one that occurred to wholesale and market-oriented banks, which are both less dependent on retail deposits.…”

Bankruptcy Codes and Risk Sharing of Currency Unions

“…Following the 2007-2009 Global Financial Crisis, there has been a revival of inside money modelling due to the renewed interest in banks' balance sheet transformation for credit extension and liquidity creation and the associated macro-financial outcomes. Recent advances include and are not limited to Bigio and Weill (2016), Brunnermeier and Sannikov (2016) , Faure and Gersbach (2017), Donaldson et al (2018), Bianchi and Bigio (2020), Piazzesi andSchneider (2018), McMahon et al (2018), Kiyotaki and Moore (2018a), Kiyotaki and Moore (2018b), Wang (2019), and Kumhof and Wang (2020). Sharing a similar spirit, liquidity creation is also much emphasised in the literature on banking (see Gorton and Pennacchi 1990;Diamond and Rajan 2001;Stein 2012;Hart and Zingales 2014;DeAngelo and Stulz 2015) and safe assets (see J Caballero and Farhi 2017).…”

Making Sense of Negative Nominal Interest Rates

“…As a general point, when a paper contains both a small illustrative model and a calibrated general equilibrium model, the discussion in this section refers to the general equilibrium model using the baseline calibration. It is also worth noting that we will discuss some papers that do not specifically analyze negative nominal interest rates, but that instead analyze a low rate environment where the policy rate is close to zero, specifically: Balloch and Koby (2019), Wang (2019), and Kumhof and Wang (2020). 22 In Table 6, an asterisk is used to denote the papers that do not explicitly analyze negative nominal interest rates.…”

“…In Onofri et al (2021), banks can fund themselves using bank bonds that follow the policy rate into negative territory, which allows the funding rate, and hence the lending rate, to fall. Finally, the deposit supply channel plays an important role in papers like Wang (2019) or Kumhof and Wang (2020).…”