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Negative policy rates are a relatively new tool for central banks and it is important to understand their implications, particularly for financial markets, which are important intermediaries in the transmission of monetary policy actions to the real economy.
This paper proposes a new model to extract the impact of negative interest rates on the yield curve which fits the data much better than alternative models. This new model introduces two latent state variables that capture the immediate and longer horizon monetary policy stances, respectively, in order to describe the rich dynamics playing out at the short end of the yield curve. These two policy indicators guide the time variations of the effective lower bound of interest rates which, in turn, govern the shape of the short end of the yield curve.
Authors use the model to extract the market's expectations of the ECB's negative interest rates from the yield curve. They find that the cuts in June 2014, when the ECB first moved into negative territory, and December 2015 were expected one month ahead. However, the September 2014 cut was unanticipated. Most interestingly, the March 2016 cut was expected four months ahead of time.
They then evaluate the impact of negative interest rates on the yield curve with a hypothetical analysis. Authors find that, if the central bank had committed to an expansionary policy in both the short and long run in June 2017, the two-year yield would have decreased by 0.2% and the long term yield by 0.16%.