Author: Guido della Valle, Erald Themeli, Mr. Romain M Veyrune, Ezequiel Cabezon, and Shaoyu Guo
Based on the experience of the Bank of Albania, the paper proposes a framework to
estimate the interest rate lower bound in small, open, and euroized economies. The paper
introduces a stylized monitoring tool to assess the unintended consequences of low policy
rates. The paper is the first attempt to estimate the impact of low interest rate on the public’s
demand for banknote by denomination. A strong preference for banknotes leads economic
agents to require a higher remuneration of banks’ deposits, lifting the lower bound above
zero. Financial euroization also lifts the lower policy bound due to the higher propensity of
substituting domestic with foreign currency–denominated assets as a function of the interest
rate differential. Policies aiming at reducing financial euroization contribute to bring down
the lower bound.
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