The European Central Bank (ECB) is one of the closely watched central banks in the world. It faces more challenges than its peers, as the Euro area lacks common fiscal institutions.
On top of that, the ECB uses the national central banks in each member state to implement its decisions, but the economic differences between countries are huge. Yet, the same policy applies to Germany or Greece, although they face different economic conditions.
This upcoming September marks one year since the ECB changed its interest rates. When talking about interest rates, few traders are aware that the ECB sets three, not one interest rate. However, everyone talks about the ECB keeping the rates negative – false, it only keeps one below zero.
Positive Effects of Negative Rate on the ECB Deposit Facility
The rate that matters the most for financial markets is the deposit facility. This is the rate that banks use when making overnight deposits with the Eurosystem. Last time it was lowered in September 2019, and it is negative since 2014. Therefore, for six years now, the ECB keeps its deposit facility in negative territory, currently at -0.5%.
A recent report by the ECB reveals what it learned so far from this experience. Keep in mind that negative interest rates are something new in the monetary policy world, and not all central banks have the gut to go there. Some did and did not like what the effects were (e.g., European Nordic states). Some other ones see no real damage (e.g., Switzerland, Japan).
The ECB learned that negative rates lead to higher risk-taking by banks. In doing so, banks support monetary transmission and promote investment and even employment.
But there is a catch to what the ECB says. And that twist has been used by the Fed when asked if it will move the federal funds rate into negative. The Fed’s answer was that it does not think that would be a wise move for the U.S. monetary policy because the positive effects of such a move appear to be evident only during economic expansion.
In other words, the ECB draws conclusions on its negative interest rate on the deposit facility solely based on a period where the Euro area economies experienced economic growth.
The real test takes place right here and now. As the coronavirus economic recession just began, the ECB’s theory regarding positive effects on its negative rate will be tested to extreme.