The ECB has set deposit rates for banks at a negative rate. The refinance rate has gone from 25 bps to 15 and the bank deposit rate has gone from zero to -10 bps. The purpose is to stimulate the EU economy and push inflation back up to the ECB target of 2% from the current levels of .5%. The big question is how do we go from negative nominal rates for banks to inflation of 2%.
So let's think about what just happened. If you are bank and held excess reserves at the central bank, you will now be charged a penalty rate. This is a tax on excess reserves. The idea would be that if there is a penalty rate there will be an incentive for banks to lend more which will decrease the amount of excess reserves. Excess reserves usually occur if there is there slack lending.
But let's take a very simple real case. What if the banks have not been lending because they cannot find good loan prospects? The excess reserves at zero rates were left at the central bank because there was a shortage of loan demand not supply. Now, if you were a banker, would you lend money to risky borrowers if you are penalized at 10 bps? If you have done banking you find out very quickly that it takes a lot of good loans to make up for one bad loan. The loan rate has to cover the expected default rate plus a profit over the cost of funds. Do you think banks will believe that the incentives to them have not changed now that rates are at 10 bps penalty?
They have also offered longer term loans to banks if they make new loans, but if they have excess reserves, you may not want to borrow the money except if you were a bad bank credit. If the money is cheap, take it, but it is not clear whether either of these policies will get the economies going. the output gap is still significant.
ECB President Draghi, "Are we finished, no." This is a clear signal that European QE is being prepared. He said as much. It also tells us that the ECB may not be sure that the negative rates will work.
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