CFA Level I · CFA Level I Exam · Monetary Policy
Which of the following is the most likely reason that a central bank pursuing a negative interest rate policy faces a limit on how far it can lower the policy rate?
The most likely limit is that savers can switch from deposits into physical cash, which yields zero, once rates become sufficiently negative. This creates an effective lower bound on the policy rate, despite storage and security costs of holding cash.
- ASavers may switch from bank deposits to holding physical cashCorrect
- BBond prices fall whenever yields turn negative
- CInflation expectations always rise when rates become negative
Explanation
If deposit rates become sufficiently negative, depositors can hold cash, which earns zero, so there is an effective lower bound. Bond prices rise, not fall, when yields decline, and inflation expectations do not necessarily rise.
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