When recessions hit, the US Federal Reserve lowers its target interest rate–the “federal funds interest rate.” This interest rate applies to extremely safe borrowing: essentially, to overnight borrowing by large and safe financial institutions. The idea is that by altering this ultra-safe interest rate, other riskier interest rates will also be under pressure to adjust, so the lower federal funds rate will be passed through by a country’s financial sector to lower rates for mortgage lending, car lending,and the like (as well as to lower interest rates paid to those with deposits in banks or money market funds).
But in the Great Recession and its aftermath, the Fed ran into a problem: it took the federal funds interest rate to just barely above zero percent. Here, it ran into what economists sometimes call the “zero lower bound.” The Fed felt that it couldn’t make interest rates negative (instead of the bank paying interest to depositors, the depositors would pay interest to the bank?). Thus, the Fed felt as if it needed to try other policies for stimulating the economy with names like “quantitative easing,” “forward guidance,” and the like.
But the European Central Banks, along with central banks in Switzerland, Sweden, Denmark, and Japan, decided to break through the “zero lower bound” (often abbreviated as the ZLB) and try out a negative policy interest rate. I wrote about this when it was happening: for example, “Negative Interest Rates: Practical, but Limited” (March 15, 2021), ”Negative Interest Rates: Evidence and Practicalities” (August 8, 2017); ”What Else Can Central Banks Do?\” (October 24, 2016); and ”Fed Policy: Negative Interest Rates, Neo-Fisherian, or No Change” (August 26, 2016).
But now we have the advantage of a few years to look back at the experience. Michael McLeay, Silvana Tenreyro, and Lukas von dem Berge look back at the evidence in “Negative Rates and the Effective Lower Bound: Theory and Evidence” (Journal of the European Economic Association, 24: 1, February 2026, pp. 1–57). The paper is based on the FBBVA Lecture delivered at the 2025 meetings of the European Economic Association. The second half of the paper is technical stuff (that is, it’s a new model of a heterogeneous, oligopolistic banking sector, with high- and low-deposit banks, embedded in an “open-economy macroeconomic model, featuring exchange-rate and capital market transmission channels). But the basic fact patterns at the start of the paper, which the model seeks to capture, are an easy read.
The short answer is that when central banks moved the key policy interest rate (slightly) below zero, it did seem to provide additional economic stimulus without weird or disastraous consequences. Here are some top-line takeaways.
- “Empirical Observation 1. Pass-through of policy rates to household deposit rates is bounded by the ZLB. Meanwhile, corporate deposit and wholesale funding rates can fall below zero.”
- “Empirical Observation 2. At low or negative policy rates, aggregate pass-through to bank lending rates and volumes still occurs, though it is typically reduced and potentially delayed.” However, the authors cite studies that the pass-through rate of negative interest rates to lower interest rates on loans in the economy is not 1:1. The pass-through of negative interest rates in the euro area seems to have been more than 50%, but in some other countries, it was less than that.
- “Empirical Observation 3. Aggregate banking sector profitability is not necessarily adversely affected by negative policy rates, and may even improve owing to general equilibrium effects.” A concern with negative interest rates was that if banks were pressured to lend at extremely low interest rates, then the banks might go broke. But it turns out that the macroeconomic benefits banks received from lower interest rates stimulating the economy tended to offset the lower bank profits from lending at lower rates.
Of course, none of this means that it would be necessarily sensible policy for a central bank to make its policy interest rate deeply negative. But it turns out that businesses in particular can function with a negative interest rate at their bank–that is, they pay interest to the bank on their deposita at the bank. Also, as we have seen in the US, people can function with banks paying essentially zero interest on their deposits as well. I suspect the reason is that it’s worth something to business and to people to make and receive payments through the banking system (say, a business making payroll, or a person having paychecks automatically deposited). As a result, when a bank is paying zero or even slightly negative interest on deposits, the bank will not lose all of its deposits.
