Negative policy rates can convince markets that deposit rates will remain lower-for-longer, even when current deposit rates are constrained by zero. This is the signalling channel of negative interest rates. We analyse the optimality and effectiveness of negative rates in the context of this novel transmission channel. In a stylized model, we prove two necessary conditions for optimality: time-consistency and a preference for policy smoothing. In an estimated model, we show the signalling channel dominates banks’ costly interest margin channel. However, the effectiveness of negative rates depends sensitively on the degree of policy inertia, level of reserves, and ZLB duration.
Keywords: Monetary policy, Taylor rule, forward guidance, liquidity trap