Global Business and Economics Program Nonresident Senior Fellow Megan Greene writes for Open Markets on the new measures announced by the European Central Bank during its executive board meeting on June 5:
ECB president Mario Draghi announced a series of measures in an attempt to reverse persistent low inflation. These measures were by the ECB’s standards bold; they would have been unthinkable even two years ago. Here are the three main actions the ECB took, and the possible outcomes of each:
The Action: The ECB cut interest rates even lower
The policy rate was cut 10 basis points to 0.15 percent, which is unlikely to make much difference. More importantly, the central bank cut its deposit rate to negative 0.1 percent. This means that banks will be charged to deposit any excess reserves they hold at the ECB overnight. The idea is that banks will be encouraged to lend the cash rather than holding on to it.
The Outcome: Unfortunately, it is unclear that banks will lend their cash. In Denmark when a negative deposit rate was introduced, banks simply passed the charge to part money with the central bank along to their customers, thereby raising borrowing rates for companies and households. A negative deposit rate could cause the euro to depreciate, which would boost Eurozone exports and make imports more expensive —thereby putting upward pressure on prices. Indeed the euro depreciated immediately after this measure was announced, but regained its value vis-à-vis the U.S. dollar within two hours.