New Zealand is considering negative interest rates as it grapples with the severe economic impact of the coronavirus pandemic.
In its rate decision this week, the central bank kept its official cash rate at 0.25% but also increased the possibility of a negative range.
"The severe global economic disruption caused by the pandemic continues. Any significant change in the global and domestic economic outlook remains dependent on the containment of the virus, which is very uncertain as the return to social constraints in New Zealand shows today." it said in a statement on Wednesday.
Adrian Orr, Governor of the Reserve Bank of New Zealand, told CNBC's Squawk Box on Friday that the negative interest rate option would not be used alone but as part of a package of measures to address the health crisis.
"Negative interest rates will not happen by themselves, which is why we talked about a package of measures, as each instrument alone will only have some effectiveness," he said.
"We're still very confident that monetary policy is effective, but it's not the main game in town," Orr said, adding that fiscal policy also needs to be addressed.
People wait for a walk-in Covid-19 test in Auckland, New Zealand on August 14, 2020. Covid-19 restrictions have been reintroduced across New Zealand.
Fiona Goodall | Getty Images News | Getty Images
The New Zealand economy contracted 1.6% in the March quarter, the largest decline in 29 years. According to the finance minister, the decline is expected to be even worse in the June quarter.
The country was virus-free for more than 100 days before a recurrence of coronavirus cases occurred in its largest city, Auckland, in the past few weeks. The development prompted authorities to lock the city again on Wednesday and impose movement and travel restrictions for three days. Since then, more cases have been confirmed and linked to the new cluster.
According to Reuters, New Zealand will decide today whether the final lockdown should be relaxed or extended.
Lowering interest rates would typically lower loan and deposit rates, encouraging businesses and individuals to invest and spend more – measures that encourage economic growth.
In theory, negative interest rates should have the same effect. Some economists said that if commercial banks have to pay to deposit money at the central bank instead of earning interest on those reserves, they should be encouraged to borrow that money instead.
However, some studies found that negative interest rates did not work in Japan and some European economies and actually reduced bank profits.
When asked how ready New Zealand banks are to switch to negative interest rates, Orr said "the majority of banks are ready".
He added that he did not want to be "held hostage" by banks who said they were not ready.
"The banks themselves know that they will be operational by at least December," he said. "We have time to think about the training, we need the operational skills … and the oversight that we need to see … bank how effective (it is)."
– CNBC's Yen Nee Lee contributed to this report.