2/2020 The impact of negative interest rates on the Estonian economy and financial sector

Occasional Papers of Eesti Pank 2/2020
Authors: Helen Ljadov, Reet Reedik, Raido Kraavik, Taavi Raudsaar, Lauri Matsulevitš, Dmitry Kulikov, Kaspar Oja, Lenno Uusküla, Nicolas Reigl, Karsten Staehr

Several central banks have started using negative interest rates alongside other nonstandard monetary policy measures to stimulate their economies and inflation. The European Central Bank cut the interest rate on its standing deposit facility to below zero in summer 2014, and was the first of the larger central banks to take such a step. Low interest rates for loans and deposits should encourage consumption and investment and so help revive the economy.

It was assumed at first that such an unusual monetary policy measure would last only for a short time, but negative interest rates have now been in place for six years in the euro area and financial markets forecast that they will remain in the coming years. There is increasing discussion, however, about where the line should be drawn, and how far interest rates can fall and for how long before their negative sideeffects start to outweigh their positive effects on lending and the economy as a whole.

This paper brings together research and reviews by experts from Eesti Pank covering the direct impact of negative interest rates on the economy and the general impact of monetary policy during the time that monetary policy interest rates have been negative. The first chapter gives the theoretical background for how negative monetary policy interest rates should function and considers the transmission channels in the euro area. The second chapter discusses the experience of other countries. The third chapter analyses the impact of negative interest rates on the financial sector in Estonia and the euro area. In this it is not always overly important whether the interest rates are negative or are very low for a long time, as the impact is quite similar in both cases. The fourth chapter analyses the impact of negative interest rates on borrowers, savers and the real estate sector in Estonia. The fifth chapter focuses on how the monetary policy of the European Central Bank affects economic growth and inflation in Estonia. It looks at the development of real interest rates in Estonia and other countries in the euro area and how synchronised the economic cycles of members of the monetary union are with the cycle of the euro area. We also research whether monetary policy was transmitted differently while interest rates were negative from how it was earlier. The Appendix to this review is a summary of a recently published analysis of the impact of negative interest rates in five Central and Eastern European countries in the euro area.