Question

1) Several central banks have used negative official interest rates in recent years, which until recently seemed unimaginable. Indeed, economists used to talk about a zero interest-rate boundary (ZIRB). How is it possible for a central bank to cut its official interest rate below zero?

2) Japan has the world's highest level of government debt. The interest rate (or yield) on 10-year Japanese government debt has been approximately zero for the past three years. What has made this possible? How is it related to quantitative easing?

Answer 1

WHAT IS CENTRAL BANK : A Central Bank is a Financial Institution given access or control over the production and distribution of money and credit for a nation or a group of nations.

The Central Bank is responsible for creating Monetary Policy and regulation of Member Banks.Though some banks are nationalized many are not government agencies.Even if a central bank is not legally owned by the government, its priveleges are established and protected by law.

Central Bank responsibilities range widely depends on their country. To control monetary policy central banks issue currency and set interest rates on loand and bonds. Central Bank increase interest rates to reduce the growth and avoid inflation in an economy. Simultaneously they lower interest rates to increase growth.

By setting aside a reserve requirement, central banks dictate how much banks can lend loan to customers and how much capital they must keep on hand.

Also when providing banking services to other banks and government, central bank lends money to members and oversees their activity. They also manage foreign exchange reserves.

Monetary Policy : A Monetary Policy is the action a central bank takes to influence a country's money supply and the overal economy.

NEGATIVE INTEREST POLICY RATE : A negative interest rate policy (NIRP) is an unusal monetary policy tool employed by a central bank whereby nominal target interest rates are set with a negative value, below zero percenttt.

Target Rate : The interest rate charged by one bank for an overnight loan of money stored at the Federal Reserve to another bank,as determined by committee of the Reserve bank. This is set during times of economic uncertainity. Target rate is often related to risk free rate in an economy.

Negative Interest Rate Policy means depositors are actually charged to keep their money on a savings account, as opposed to receive interest on their deposits.

Why Does a Central Bank initiate an NIRP: During Deflationary periods ( a slow down in the inflatin ) (having shortage of money in circulation) when people and businesses keep their cash idle instead of spending and investing it.

Aggregate Demand collapses which leads to falling prices, slowing production and more unemployment.

Thus when interest rates fall below zero the costs for companies and individuals to borrow falls, which in turn inccreases demand for loans , investment and consumer spending.

Banks lend money more freely and borrowers are interested to spend their cash.

• A negative interest rate policy occurs when a central bank sets its target nominal interest rate at less than zero percent.
• This monetary policy tool is used to encourage borrowing, spending and invest rather than hoarding cash.

QUANTITATIVE EASING : Its a form of monetary policy where central banks quicky increase the domestic money supply and spur the economic activity.

Central bank purchases long term government bonds and othher assets mortgage etc.,

Japan to lower its burden of debt , its central bank reduces the interest rate and purchases government bonds to stock the financial system with more cash.

Thus quantitative easing was adopted by the central bank of japan inorder to increase the supply of domestic money in the economy.