Our job at the ECB is to keep prices stable. We do so by aiming for an inflation rate of 2% over the medium term. Like most central banks, we influence inflation by setting interest rates. If the central bank wants to act against too high inflation, it generally increases interest rates, making it more expensive to borrow and more attractive to save. By contrast, if it wants to counter too low inflation, it reduces interest rates.
In 2014, euro area inflation was expected to remain considerably below our objective for a prolonged period. For this reason, the ECB's Governing Council judged that it needed to lower interest rates in June of that year. The ECB has three main interest rates on which it can act: the marginal lending facility for overnight lending to banks, the main refinancing operations and the deposit facility. The main refinancing rate is the rate at which banks can regularly borrow from the ECB while the deposit rate is the rate banks receive for funds parked at the central bank. All three rates were lowered. The cut was part of a combination of measures designed to ensure price stability over the medium term, which is a necessary condition for sustainable growth in the euro area.
Do I have to pay my bank to keep my savings when policy rates are negative? What is the effect of a negative deposit rate on my savings?
Commercial banks may of course choose to lower interest rates for savers and some passed on the negative rates to customers holding large deposits. At the same time, though, consumers and businesses could borrow more cheaply and this helped stimulate economic recovery.
In a market economy, the return on savings is determined by supply and demand. For example, low long-term interest rates are the result of low growth and an insufficient return on capital. The ECB's interest rate decisions benefited savers in the end because they supported growth and thus created a climate in which interest rates could gradually return to higher levels.
But why punish savers and reward borrowers?
A central bank's core business is making it more or less attractive for households and businesses to save or borrow, but this is not done in the spirit of punishment or reward. By reducing interest rates and thus making it less attractive for people to save and more attractive to borrow, the central bank encourages people to spend money or invest. If, on the other hand, a central bank increases interest rates, the incentive shifts towards more saving and less spending in the aggregate, which can help cool an economy suffering from high inflation. This behaviour is not specific to the ECB; it applies to all central banks.
Isn't it possible for banks to avoid the negative deposit rate? For example, can't they simply decide to hold more banknotes?
If a bank holds more money than is required for its minimum reserves and if it is not willing to lend to other commercial banks, it has only two options: to hold the money on an account at the central bank or to hold it as cash. But holding cash is not cost-free either − not least since the bank needs a very safe storage facility to warehouse the banknotes. So it is unlikely that any bank would choose to do this. The more likely outcome is that banks either lend money to other banks or pay the negative deposit rate.
Source: European Central Bank
Published: 12 June 2014
Updated: 28 July 2022
The above presentation was created for educational purposes.