The Effective Lower Bound for the Policy Rate in Euroized Economies - An Application to the Case of Albania

Based on the experience of the Bank of Albania, the paper proposes a framework toestimate the interest rate lower bound in small, open, and euroized economies. The paperintroduces a stylized monitoring tool to assess the unintended consequences of low policyrates. The paper is the first attempt to estimate the impact of low interest rate on the public'sdemand for banknote by denomination. A strong preference for banknotes leads economicagents to require a higher remuneration of banks' deposits, lifting the lower bound abovezero. Financial euroization also lifts the lower policy bound due to the higher propensity ofsubstituting domestic with foreign currency-denominated assets as a function of the interestrate differential. Policies aiming at reducing financial euroization contribute to bring downthe lower bound