Are Negative Nominal Interest Rates Expansionary?

Following the crisis of 2008 several central banks engaged in a radical new policy experiment by setting negative policy rates. Using aggregate and bank-level data, we document a collapse in pass-through to deposit and lending rates once the policy rate turns negative. Motivated by these empirical facts, we construct a macro-model with a banking sector that links together policy rates, deposit rates and lending rates. Once the policy rates turns negative the usual transmission mechanism of monetary policy breaks down. Moreover, because a negative interest rate on reserves reduces bank profits, the total effect on aggregate output can be contractionary.