Learning objectives: Describe the framework that led to the introduction of negative policy rates. Explain the implications of the technical implementation of negative policy rates. Identify factors that determine the lower bound for nominal interest rates. Identify and compare the risks associated with negative policy rates
Questions:
706.1. Among the following motivations or justifications, which is the most plausible reason for a central bank such as the European Central Bank (ECB) to introduce a negative policy rate?
a. To counter the threat of deflation, or to counter a subdued inflation outlook that is below the target
b. To preemptively prevent equity prices from spiking too high and creating a asset bubble as a result of the discount factor
c. To discourage capital outflows from the central bank's home country and into emerging foreign markets as "hot money" flows
d. To indirectly depreciate the central bank's own currency by relying on interest rate parity (IRP) to compel domestic currency depreciation due to a lower rate than foreign counties' rates
706.2. The authors of this reading studied five central banks who moved their policy rate below zero: Danmarks Nationalbank (DN), the European Central Bank (ECB), Sveriges Riksbank, the Swiss National Bank (SNB) and the Bank of Japan (BoJ). Four of the banks kept their policy rate below zero for more than one year. With respect to the decision-making assumption(s), technical implementation, and the lessons learned, each of the following is true EXCEPT which statement is false?
a. In practice, modestly negative policy rates were transmitted to money market rates in very much the same way as positive rates, without adversely affecting the functioning of money markets
b. The classically academic theory of the "zero lower bound" anticipates that zero ought to be natural lower bound for the policy rate because physical cash (if we assume no storage cost) earns a zero nominal return
c. In practice, zero did demonstrate to be a binding limit due to prevalent operational constraints and technical limits, in particular contractual terms and instrument features such as an inability to operationalize negative coupons
d. In practice, at least among the central banks studied in this paper, retail bank customers were largely shielded from negative policy rates as banks were reluctant to pass along negative rates through to retail depositors
706.3. According to the authors, the risks associated with negative policy rates include each of the following EXCEPT which is not true?
a. Profit margins of banking sector are squeezed
b. Soundness of firms with long-duration liabilities; e.g., insurance companies, pension funds
c. Bond durations (aka, interest rate risk) increase and, in the case of zero-coupon bonds durations can actually exceed maturity
d. Risky long-term investments (e..g, capital projects) are discouraged and displaced by lower levels of consumer spending and higher levels of consumer savings
Answers here:
Questions:
706.1. Among the following motivations or justifications, which is the most plausible reason for a central bank such as the European Central Bank (ECB) to introduce a negative policy rate?
a. To counter the threat of deflation, or to counter a subdued inflation outlook that is below the target
b. To preemptively prevent equity prices from spiking too high and creating a asset bubble as a result of the discount factor
c. To discourage capital outflows from the central bank's home country and into emerging foreign markets as "hot money" flows
d. To indirectly depreciate the central bank's own currency by relying on interest rate parity (IRP) to compel domestic currency depreciation due to a lower rate than foreign counties' rates
706.2. The authors of this reading studied five central banks who moved their policy rate below zero: Danmarks Nationalbank (DN), the European Central Bank (ECB), Sveriges Riksbank, the Swiss National Bank (SNB) and the Bank of Japan (BoJ). Four of the banks kept their policy rate below zero for more than one year. With respect to the decision-making assumption(s), technical implementation, and the lessons learned, each of the following is true EXCEPT which statement is false?
a. In practice, modestly negative policy rates were transmitted to money market rates in very much the same way as positive rates, without adversely affecting the functioning of money markets
b. The classically academic theory of the "zero lower bound" anticipates that zero ought to be natural lower bound for the policy rate because physical cash (if we assume no storage cost) earns a zero nominal return
c. In practice, zero did demonstrate to be a binding limit due to prevalent operational constraints and technical limits, in particular contractual terms and instrument features such as an inability to operationalize negative coupons
d. In practice, at least among the central banks studied in this paper, retail bank customers were largely shielded from negative policy rates as banks were reluctant to pass along negative rates through to retail depositors
706.3. According to the authors, the risks associated with negative policy rates include each of the following EXCEPT which is not true?
a. Profit margins of banking sector are squeezed
b. Soundness of firms with long-duration liabilities; e.g., insurance companies, pension funds
c. Bond durations (aka, interest rate risk) increase and, in the case of zero-coupon bonds durations can actually exceed maturity
d. Risky long-term investments (e..g, capital projects) are discouraged and displaced by lower levels of consumer spending and higher levels of consumer savings
Answers here:
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