This paper estimates the effects of monetary policy in the United States, the euro area and Japan when short-term interest rates are near zero or even negative, ie their effective lower bound (ELB). The ELB periods extend from January 2009 to December 2015 for the US economy, since July 2012 for the euro area, and since January 1996 for Japan. That monetary policy would be effective in such conditions is not a given, as the central bank can no longer lower interest rates to spur credit, asset prices and economic activity. This analysis is important because interest rates may remain at or near their ELB in the decade ahead.
In this article, we estimate the effect of monetary policy shocks in situations where the short-term interest rate is near its ELB and compare these estimates with the ones obtained in "normal times", ie in previous periods when the short-term interest rate fluctuated at positive levels. We present and discuss state-of-the-art (Bayesian (structural vector autoregressive) identification) estimates that are consistent for the United States, the euro area and Japan.
We show that monetary policy has remained fairly effective in stimulating output and inflation in spite of the proximity of short-term interest rates to their ELB. Increases in the supply of money by the central bank work their way through the credit channel. These results are consistent for the United States, the euro area and Japan. We find very little evidence, at least so far, that lower levels of short-term interest rates have made monetary policy impotent. There is little backing in the data for a "liquidity trap" that would be relevant at the macroeconomic level.
The liquidity trap is synonymous with ineffective monetary policy. The common wisdom is that, as the short-term interest rate nears its effective lower bound, monetary policy cannot do much to stimulate the economy. However, central banks have resorted to alternative instruments, such as QE, credit easing and forward guidance. Using state-of- the-art estimates of the effects of monetary policy, we show that monetary easing stimulates output and inflation, also during the period when short-term interest rates are near their lower bound. These results are consistent across the United States, the euro area and Japan.
JEL classification: E32, E44, E52
Keywords: liquidity trap, effective lower bound, monetary transmission
Read the full paper at: https://www.bis.org/publ/work855.htm