Pushing and pulling on a string? Inflationary effects of expansionary and contractionary monetary policies when rates are negative

Abstract

Theoretically, the effect of conventional monetary policy may reverse when policy rates are cut into negative territory. Empirical literature provides evidence that cutting policy rates extremely low can be harmful for bank lending. Using euro area data from the period 2014–2022, we study whether this has implications for the transmission of monetary policy to inflation – the key variable for many central banks. Specifically, we study whether contractionary and expansionary monetary policy changes cause equally large inflation effects when nominal interest rates are extremely low. We analyse separately conventional and different types of unconventional monetary policies. We find that inflation effects of policy rate cuts are muted when policy rates are already negative in line with the theory about reversal rate. Both expansionary and contractionary quantitative easing shocks are found to have inflationary effects. We also provide evidence that different policy tools are more effective when used together.