Estimating Monetary Policy Effects When Interest Rates are Bounded at Zero

Abstract

Using a nonlinear structural VAR approach, we estimate the effects of exogenous monetary impulses in the presence of a zero lower bound constraint on nominal interest rates and examine the impact of such a constraint on the effectiveness of counter-cyclical monetary policies. We find that a binding zero bound on nominal interest rates can eliminate more than 50% of the effect of an exogenous monetary impulse on output based on the data from Japan. The conditional impulse response functions allow us to isolate the effect of monetary shocks operating through the interest rate channel when other possible channels of monetary transmission are present. Moreover, we also find that the zero bound on nominal interest rates could severely limit the ability of central banks to pursue a counter-cyclical monetary policy when facing adverse macroeconomic shocks.