Effectiveness of Negative Interest Rate as a Monetary Policy Tool in Influencing Long-term yields

Abstract

In unprecedented economic times, governments and central banks have been faced with monetary policy decision that are almost entirely unfamiliar. Due to this, monetary policy has evolved into directions not commonly seen before. These developments have caused significant discussion on their usefulness and effectiveness in achieving monetary policy goals. One of these unconventional measures, and possibly the most debated one due to its counter-intuitive nature are Negative Interest Rates. In attempting to stimulate spending and increase inflation, banks have decreased the short-term interest rates to remarkably low levels. This however has had limited impact and it has been theorized that, assuming zero is the lower bound for interest rates, as the short-term rate approaches this, the monetary policy loses its effectiveness. This has led to the suggestion of implementing negative interest rates to give central banks and policy makers a new way to influence the financial markets. A particularly direct way of looking at the effectiveness of these short-term interest rate policy changes is through their impact on long-term rates as this should reflect the expectations of the market. There have been several studies performed in this field although troubled by limited data. This thesis intends to add to the understanding of negative interest rates by building on the studies of Grisse and Schumacher (2017) while using their approach to add insights into how the effectiveness of negative interest rates for policy makers can be observed in different markets (Italy and Sweden).