The yield and forward curves observed in the market are the probability-weighted averages of these possible paths, aggregated across market participants. A perceived binding lower bound on monetary policy rates skews the predictive distribution upward, since it truncates the distribution of conceivable future short-term rates from below: as the overnight interest rate reaches the lower bound, interest rate paths that would have embodied expectations of a further cut at a higher level of the actual overnight rate are, by definition, eliminated from the set of conceivable outcomes; conversely, rates above the lower bound receive a higher relative weight and the expected value of interest rates is mechanically pushed up.3 While longer-term yields are likely to decline even as the central bank cuts the short-term rate towards its lower bound, the truncated asymmetric distribution of expected future short-term rates means that they decline by less than they would away from the lower bound. The resultant tightening bias, in turn, can be quite costly, since it tends to arise in situations of strong and persistent disinflationary pressures and in the wake of a previous sequence of sizeable rate cuts. A policy of negative interest rates mitigates this tightening bias. In particular, the observation that a central bank is prepared to take interest rates to levels below zero induces a re-evaluation of technical feasibility constraints. A salient feature of this re-evaluation is the disappearance of the qualifier “zero” in the economic debate on lower bound constraints.
The funding cost relief is direct for those banks that switch from more expensive options to 9 / 19  BIS central bankers' speeches  TLTRO financing. However, there is also an indirect channel that benefits the entire banking system: while looking ahead banks will have to step up their issuance in order to satisfy regulatory requirements, the TLTRO programme will help avoid cliff effects by allowing banks drawing TLTRO funds to cancel or postpone plans to issue bonds in the market. This reduction in the supply of securities relative to what we would see in the absence of TLTRO III creates a scarcity channel that puts further downward pressure on bank bond yields, resulting in funding cost relief across the board. The upshot of cheaper bank funding is higher credit volumes and lower lending rates to the wider economy via the bank lending channel.9  10 / 19  BIS central bankers' speeches  In fact, our experience with previous TLTROs (TLTRO I and II) was that these operations had a significant effect on funding costs, particularly in more vulnerable euro area countries. Moreover, the lower funding costs were passed through to customers. Particularly in vulnerable countries, banks that participated in TLTROs cut their lending rates by more than their non-participating peers (see Chart 6). The policy package In assessing the impact of our policy package, we must also take into account that the instruments were designed to be complementary and mutually reinforcing.