Academic journal article Brookings Papers on Economic Activity

Monetary Policy at the Effective Lower Bound: Less Potent? More International? More Sticky?

Academic journal article Brookings Papers on Economic Activity

Monetary Policy at the Effective Lower Bound: Less Potent? More International? More Sticky?

Article excerpt

This paper discusses whether monetary policy at the effective lower bound (ELB) is less effective, generates greater international spillovers, or is "stickier" than conventional monetary policy. It argues that monetary policy at the ELB can be potent and that there has thus far been no convincing evidence that it has greater international spillovers through capital flows and exchange rates than comparable adjustments in interest rates. It may be more challenging to raise rates off the ELB than to raise rates from higher levels--possibly due to counterbalancing effects through the exchange rate--although there are only anecdotes to support this stickiness rather than any formal, empirical evidence.

During the 2008 global financial crisis, many advanced economies lowered their policy interest rates to their effective lower bounds (ELBs). In some countries, these interest rates are still there. In the future, there is a good chance that many central banks will operate at the ELB more often, especially given the fall in the global neutral interest rate (r*) and the high probability that the next slowdown will come before interest rates are raised to levels from which they could be lowered enough to provide a substantial stimulus. Understanding how monetary policy at the ELB is different from "conventional" monetary policy is therefore critical for thinking about monetary policy in the future.

This paper explores three ways in which monetary policy at the ELB may differ from more "conventional" monetary policy--defined as primarily consisting of changes in the central bank's main policy rate. First, it asks whether monetary policy at the ELB is less effective, making it difficult for the central back to meaningfully support the economy. Second, it asks if monetary policy at the ELB has larger international spillovers--through larger effects on the volume and volatility of capital flows or on exchange rates. Third and finally, it discusses whether the ELB is "sticky," in the sense that adjustments in monetary policy around the ELB generate disproportionate feedback effects that make it harder to tighten this policy.

Each of these questions addresses concerns that have been raised about monetary policy at the ELB--concerns that could provide reasons to adjust monetary frameworks in order to reduce the probability of reaching the ELB in the future. I do not venture into this broader debate, but simply focus on whether these arguments for concern about the ELB are valid. My attempts to answer these questions are far from definitive; if anything, the discussion suggests the need for more careful analysis of these important questions.

The preliminary evidence, however, suggests that these concerns about the ELB may be overstated. Monetary policy made with "unconventional tools" can be effective at the ELB, assuming there are no political constraints on using these tools. There is also little convincing evidence to date that monetary policy at the ELB has greater international effects than would occur through comparable adjustments in interest rates on the volume or volatility of capital flows, or on exchange rates. Whether raising interest rates after being at the ELB is more challenging than raising rates from more normal levels is an open question--and one that has been even harder to answer, given the small number of countries that have thus far successfully exited the ELB. In fact, all these questions are difficult to answer because any changes in the effectiveness and channels of monetary policy since the 2008 crisis could reflect changes related to operating at the ELB--or the many other structural changes in the global economy that have occurred over this period. On a more positive note, if the current improvement in global growth and inflation continues, there should be more examples of countries exiting the ELB and therefore more evidence to help answer these questions.

I. Is Monetary Policy at the ELB Less Potent? …

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