Lower Bound Beliefs and Long-Term Interest Rates

Abstract

We study the transmission of changes in the believed location of the lower bound to longterm interest rates since the introduction of negative interest rate policies. The expectations hypothesis of the term structure combined with a lower bound on policy rates suggests that normal policy transmission is reduced when policy rates approach this lower bound. We show that if market participants revise downward the believed location of the lower bound, this may in itself reduce long-term yields. Moreover, normal policy transmission to long-term rates increases. A crosscountry event study suggests that such effects have been empirically relevant during the recent negative interest rate episode.

Negative Monetary Policy Rates and Portfolio Rebalancing: Evidence from Credit Register Data

“…In their model, the introduction of NIRP makes the forward curve flatter than it would be if short rates are expected to be constrained by a zero lower bound. An event study of yield reactions to negative interest rate announcements shows that long rates tend to drop in response to downward revisions in the market's believed location of the lower bound (Grisse et al, 2017). Eisenschmidt and Smets (2017) make a similar point by showing the empirical discontinuity in the shape of the forward curve around the introduction of NIRP in June 2014.…”

“…The introduction of NIRP steered market expectations by removing the ZLB, inducing a downward shift and a simultaneous flattening of the entire yield curve (e.g., Draghi, 2016;Coeuré, 2017;Grisse et al, 2017), which previous rate cuts above the ZLB (or forward guidance announcements) were unable to achieve (see Figure 3). The fall in the yield of safer, liquid assets of all maturities widened a wedge between the yields of safer and riskier assets, thus incentivizing banks to rebalance their portfolios.…”

Expansionary Yet Different: Credit Supply and Real Effects of Negative Interest Rate Policy

“…Our results suggest that NIRP works differently than rate cuts just above the ZLB. We document that the introduction of NIRP steered market expectations by removing the ZLB, inducing a downward shift and a simultaneous flattening of the yield curve (see also: Draghi, 2016;Coeuré, 2017;Grisse et al, 2017), which previous rate cuts just above the ZLB had been unable to achieve. Before the announcement of NIRP, with the policy interest rates at the perceived lower bound, the distribution of future possible rates was truncated: market participants expected that future short-term interest rates could only increase or stay at the same level.…”

Term structure dynamics at low and negative interest rates—evidence from Switzerland

“…With the introduction of the minimum exchange rate, the SNB again conducted minor liquidity-providing repo operations until April 2012. 6 Lemke and Vladu (2017) and Grisse et al (2017) generalize Ruge-Murcia's model by allowing for a varying and possibly non-zero lower bound on the short-term nominal interest rate. This allows them to study the effects of changes in the market-perceived lower bound.…”

“…11 Details are available from the authors upon request. 12 The lower boundr t is defined as the lowest policy rate level ever set among major central banks up to date t, see Grisse et al (2017).…”