Finance and Economics Discussion Series (FEDS)
November 2000
Monetary Policy When the Nominal Short-Term Interest Rate is Zero
James Clouse, Dale Henderson, Athanasios Orphanides, David Small, and Peter Tinsley
Abstract:
In an environment of low inflation, the Federal Reserve faces the risk that it has not provided enough monetary stimulus even when it has pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate has been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base that may stimulate aggregate demand by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act, The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and private-sector credit instruments (at least those that may be purchased by the Federal Reserve); unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, perhaps in some circumstances, the use of options.
Keywords: Monetary policy, liquidity trap, Federal Reserve Act, open market operations, discount window lending
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.