Banks, money and the zero lower bound on deposit rates

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 24 August 2018

Staff Working Paper No. 752

By Michael Kumhof and Xuan Wang

We study a New Keynesian model where banks create deposits through loans, subject to increasing marginal cost of lending, and where all non-banks must use deposits to make payments. We discuss three implications. First, non-banks do not face budget constraints but deposits-in-advance constraints, and both individual and aggregate purchasing power can be increased beyond prior income through ex-nihilo deposit creation. Second, at the ZLB on deposit rates (ZLBD) further policy rate reductions reduce spreads, and thereby reduce bank profitability, deposit creation and output. Third, at the ZLBD Phillips curves are flatter because credit rationing is both contractionary and inflationary.

This version was updated in July 2019.

PDFBanks, money and the zero lower bound on deposit rates

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