# How low can interest rates go? How deeply negative?

Ten years ago, negative interest rates were an impossibility, an intellectual curiosity. Now it's a common policy.

Just read a claim that there is still an absolute lower bound, even if it happens to be a little bit below zero. But having had one certainty smashed, I'm curious--what stops rates from going even further below zero?

The Bank of Japan has had very low rates for a very long time, partially made possible by the deflationary environment. Even if the money in the bank doesn't earn very much interest, it just buys more over time.

What happens if the whole world goes the way of Japan, with constant and sustained deflation? Ie, assuming all government bonds carry a negative coupon.

Say global economy that is deflating at -.06, is -.05 still the 'real world lower bound' of interest rates? Can a lower bound be said to meaningfully exist, or is there only the spread between the rate of deflation and the interest rate?

I think the economics frame of this is that the nominal rate is -.05, but less deflation -(.06), the actual interest rate is .01?

So I guess my actual question is: Is there a lower bound for nominal rates? Or are very negative rates possible as long as they are less than the rate of deflation?

(I am not an academic economist. Pardon my lack of jargon).

• What you are calling the “absolute lower bound” is probably what is commonly termed the Effective Lower Bound. However, the lower bound refers to nominal interest rates. Deflation does not effect this, it just raises the real rate of interest. As such, it’s not clear what your question is asking. Nov 4 '20 at 2:28
• Can you please provide references for the statement that zero lower bound or effective lower bound is premised on an inflationary world?
– 1muflon1
Nov 4 '20 at 3:45
• @1muflon1 - An empirical observation on the theory-building context of academic economists, not a necessary condition.
– Mox
Nov 4 '20 at 4:01
• @Mox can you then please provide a reference to the theory or for the 'theory-building' concept, whatever that is supposed to even mean, based on which you made the observation?
– 1muflon1
Nov 4 '20 at 4:03
• @Mox 1. no theories are constantly being created about problems that might not yet exist. There are literary papers on interstellar trade being published (Paul Krugman Nobel Prize winner in economics has one). I dont know of any interstellar trading company. 2. Theories are made to be general. Like the theory of relativity etc. We are always trying to cover all bases with theory. I know of no theory that would just say oh we are now only crafting theory that works in inflationary world - that is absurd and if this is your perception of academia it is incorrect
– 1muflon1
Nov 4 '20 at 4:25

Your question contains several incorrect premises, hence before providing an answer I will first correct those misconceptions as any discussion based on incorrect premises cannot be very productive.

Correction of Misconceptions

Ten years ago, negative interest rates were an impossibility, an intellectual curiosity.

This is not true at all. Clearly empirical research shows that there were periods when interest rates in some countries were slightly negative. For example, Kugler, P., & Rich, G. (2001) show that Switzerland had slightly negative interest rate in late 70s. That is about half a century ago and the paper itself is 20 years old and this was well known. So your statement is just factually not true.

In fact negative interest rates and possibility of thereof enjoyed periodic waves of interest, the most early ones dating all the way back to early 20th century (See Ilgmann, C., & Menner, M. (2011) and sources cited therein).

Just read a claim that there is still an absolute lower bound, even if it happens to be a little bit below zero. But that's premised on an inflationary world.

One cannot prove a negative but I study macroeconomics for quite some time and I have never seen anyone saying that zero lower bound (ZLB) or even effective lower bound (ELB) are premised on inflationary world. I would like to be corrected if anyone economist ever made such claim, but I doubt it and even if some do this is definitely not any claim that would be generally held by mainstream macroeconomists.

And in an economy that is deflating at -.06, is -.05 still still the 'real world lower bound' of interest rates? Can a lower bound be said to meaningfully exist, or is there only the spread between the rate of deflation and the interest rate?

ZLB or even ELB does not depend on deflation or any arbitrary rate of deflation. ZLB or ELB exists independently of what the rate of inflation/deflation is in the economy. ZLB or ELB as pointed by @BrianRomanchuk in his excellent +1 comment refer to the bounds on nominal interest rates, and even more specifically nominal interest rates on deposit accounts. Real interest, or even other nominal interest rates (such as rates implied by ECB's long-term repo operations (LTROS) rates see The Economist for explainer) can be arbitrarily negative.

The reason why ZLB or ELB exist is the existence of cash. Due to existence of cash - which is equivalent to financial paper with implicit zero nominal interest rate - there must be some ELB. Since cash and money on deposit accounts are theoretically perfectly fungible the limit on nominal interest rates should be zero. Of course in real life there are issues such as storage costs. Even without negative interest rates you are willing to pay bank to keep your money safe and as a result the interest rates can become slightly negative (Ilgmann, C., & Menner, M. (2011)).

However, slightly negative does not mean arbitrarily negative. There will be point where the nominal interest rate is so negative nobody will be willing to hold money in deposit accounts. This is trivial just consider an extreme case of negative $$-1000\%$$ interest rate. Would you hold any money on deposit account under such punitive negative nominal interest rate? I think not! Of course, this raises question what is actually the true ELB if not zero. The studies show that while this effective lower bound will be below zero, it can only go very little below zero - reasonable estimates are around $$-1\%$$ being maximum (see Hills, T. S., Nakata, T., & Schmidt, S. (2019) and sources cited therein).

Now are there some ways how this issue could be dealt with? Actually yes! Both ZLB and ELB can be easily abolished by abolishing cash. If people do not have choice of withdrawing their money from bank then interest rates can be arbitrarily negative (see Buiter 2009; Buiter 2005; Yates 2004, and Ullersma 2002, for reviews on the relevant literature). Unfortunately, it seems that most societies are not ready to give up cash yet, since despite of support for abolition of cash among experts this idea is not widely embraced by politicians.

• For the record, I have no knowledge of any economist making a claim premising ELB or ZLB on an inflationary context.
– Mox
Nov 4 '20 at 5:04
• @Mox then why did you made such a claim in your Q? I see that now you edited it out but originally you made a claim that the theory is predicated on inflationary world. Economics.SE is a science site. Here we take such claims seriously as any scientists would.
– 1muflon1
Nov 4 '20 at 5:04
• Thought-splice when writing the question. Ought to have been two lines, possible two paragraphs.
– Mox
Nov 4 '20 at 5:08
• Different stack exchanges have very different norms, I am finding. I though the relative informality of the original presentation had made it pretty clear that it was not an academic inquiry. I remind you that one of the privileges of academia is access to evidence/literature; on the far side of the paywall such articles cost \$40 each. Basing something in the literature is beyond my powers. As is even know what is in the literature.
– Mox
Nov 4 '20 at 6:31
• @Mox of course, this is why I said or ... be clear when it comes to expressing opinion, the problem was not that you expressed your informal opinion on the matter. It is completely fine to say "I always thought Y causes X" is my thinking correct? However, you did something very different. You simply stated - Y causes X like if it would be a fact. Moreover, you also made an factual claim about non-existence of negative interest rates more than 10 years ago. You could have verify that even without access to academic sources or simply avoid claiming something is a fact if you dont know
– 1muflon1
Nov 4 '20 at 13:50