Kent: Negative rates could in principle provide extra stimulus

Negative interest rate policies (NIRP) have emerged as a tool for central banks to stimulate economic activity when conventional monetary policy reaches its limits. By charging commercial banks for holding excess reserves, central banks aim to encourage lending and spending, thereby boosting aggregate demand and supporting price stability. The rationale is that negative rates reduce the incentive to hold cash and instead promote investment or consumption.

The effectiveness of NIRP has been observed in several economies, with evidence showing that wholesale interest rates have fallen in response to negative policy rates, and some lending rates have also declined, particularly in banking systems with high competition or variable-rate loans. Additionally, negative rates can help reduce exchange rate appreciation pressures in open economies by discouraging capital inflows.

However, the policy is not without limitations. One key constraint is the potential for savers and businesses to shift funds into cash to avoid negative returns, which could undermine the policy's effectiveness and destabilize the financial system. The tipping point at which cash becomes a more attractive alternative is estimated to range between -0.75% and -2.00%. Moreover, prolonged negative rates could compress bank net interest margins, especially if retail deposit rates remain near zero.

While negative rates can provide additional monetary stimulus, they are not a long-term solution. Their use must be balanced with structural reforms, fiscal support, and prudential oversight to ensure financial stability and sustainable growth.