Effective Lower Bound Research Articles

Macroeconomic effects of monetary policy in Japan: an analysis using interest rate futures surprises

AbstractWe estimate the effects of monetary policy on the aggregate economy in Japan during the last three decades when the effective lower bound (ELB) on interest rates was occasionally binding. We use monetary policy surprises from the interest rate futures market as the external instrument to identify monetary policy shocks in the vector autoregressive model. We find that monetary policy has been effective in Japan during the last three decades, and the effect was more persistent in the ELB regime than in the non-ELB regime. In a simulation exercise, we further show that a New Keynesian model with forward guidance can replicate our empirical finding.

On natural interest rate volatility

Episodes of low natural interest rates, even transitory, pose a challenge to monetary policy, by possibly causing the effective lower bound (ELB) on the policy rate to bind. Those episodes are more likely to occur not only when the natural rate is low on average but also when fluctuations around its average level are large. We study the responsiveness of the natural interest rate to structural aggregate shocks affecting the aggregate supply of and demand for savings. Using a quantitative overlapping-generations model, we trace back this responsiveness to the slopes of aggregate savings supply and demand curves and argue that both curves have likely flattened over the past four decades in the US This implies a greater sensitivity of the natural interest rate to structural shocks affecting the supply of and demand for aggregate savings — making it more likely, all else equal, that it fall into negative territory.

Assessing the Effective Lower Bound in the Context of Introducing the Digital Euro

Assessing the Effective Lower Bound in the Context of Introducing the Digital Euro

Optimal robust monetary and fiscal policy under uncertainty on the lower bound

This paper studies robust policy when the policymaker has Knightian uncertainty about the exact position of the effective lower bound (ELB). First, we characterize optimal discretionary policy when a benevolent policymaker controls the nominal interest rate and the level of government spending. Compared to the full information case, an uncertainty-averse policymaker overestimates the level of the ELB, thereby triggering a more aggressive reduction in the nominal interest rate prior to the liquidity trap. Furthermore, the anticipation of a larger increase in public spending improves the trade-off between inflation and the output gap, and dampens the perceived worst-case level of the ELB. As a result, a less conservative fiscal stabilization is desirable to address the uncertainty concerns of the policymaker by partially substituting for the nominal interest rate at the ELB. Moreover, an inflation-conservative policymaker mitigates the impact of uncertainty on equilibrium outcomes even better than a fiscally active policymaker.

Social Learning and Monetary Policy at the Effective Lower Bound

AbstractThis paper develops a model that jointly accounts for the missing disinflation in the wake of the Great Recession and the subsequently observed inflation‐less recovery. The key mechanism works through heterogeneous expectations that may durably lose their anchoring to the central bank (CB)'s target and coordinate on particularly persistent below‐target paths. The welfare cost associated with persistent low inflation may be reduced if the CB announces to the agents its target or its own inflation forecasts, as communication helps coordinate expectations. However, the CB may lose its credibility whenever its announcements become decoupled from actual inflation.

Estimation of DSGE Models with the Effective Lower Bound

We propose a new approach for the efficient and robust Bayesian estimation of medium- and large-scale DSGE models with occasionally binding constraints. At its core lies the Ensemble Kalman filter, a novel nonlinear recursive filter, which allows for fast likelihood approximations even for models with large state spaces. We combine the filter with a computationally efficient solution method for piece-wise linear models a state-of-the-art MCMC sampler. Using artificial data, we demonstrate that our approach accurately captures the true parameters of models with a lower bound on nominal interest rates, even with very long lower bound episodes. We use the approach to analyze the US business cycle dynamics until the Covid-19 pandemic, with a focus on the long lower bound episode after the Global Financial Crisis.

Fiscal policy and stock markets at the effective lower bound

We study the impact of fiscal policy at the effective lower bound (ELB) in the stocks markets of the Euro Area, by specifically looking at a government spending shock. To uncover the impact of this shock, we estimate a factor-augmented interacted panel vector-autoregressive (FAIPVAR) model. We find statistically different impacts of the government spending shock across the ELB and non-ELB periods, with relatively stronger positive impact on stock returns under the former. Conversely, the differences are not statistically significant for the United States using a time series data-based FAIVAR. Our findings have important implications from the perspectives of both policymaking and investors.

Information effects of monetary policy

This study assesses two central bank announcements about monetary policy and the central bank’s assessment of the economic outlook. We examine whether these two components influence macroeconomic and financial variables under the effective lower bound (ELB) of short-term nominal interest rates in Japan. We identify two shocks: a surprise policy tightening that raises interest rates and reduces stock prices and the complementary positive central bank information shock that raises both. We find that the two shocks have different effects on the Japanese economy. In fact, a contractionary monetary policy shock decreases inflation rates, whereas a positive central bank information shock increases inflation rates. The evidence suggests that announcements conveying the central bank’s assessment of the economic outlook play a certain role in the transmission mechanism of monetary policy under the ELB. However, our study shows that the two series of shocks do not induce changes in output. This suggests that they have a limited impact on the economy.

A horse race of alternative monetary policy regimes under bounded rationality

We introduce bounded rationality, along the lines of Gabaix (2020), in a canonical New Keynesian model calibrated to match Canadian macroeconomic data. We use the model to provide a quantitative assessment of the macroeconomic impacts of alternative monetary policy regimes—flexible inflation targeting (FIT), average-inflation targeting (AIT) and price-level targeting (PLT)—with an effective lower bound (ELB) constraint. First, our results suggest that the benefits of adopting history-dependent monetary policy regimes rely on two important assumptions: rational expectations and the central bank’s emphasis in stabilizing real variables such as the output gap. The macro-stabilization advantage of PLT disappears even for small deviations from rational expectations, and it is especially undermined when the central bank assigns a high weight on output volatility. Second, the presence of cost-push shocks, such as the ones global economies have experienced since the recovery from the pandemic, introduces important policy trade-offs that poses practical challenges which are best tackled using an AIT regime. Third, in choosing the optimal window width under the AIT regime, a central bank that assigns some emphasis on real sector stability needs to be mindful of expectation formation. If economic agents are sufficiently far from being rational, our simulations indicate that the optimal window is between 1 and 2.5 years.

Credible Forward Guidance

How can the central bank credibly implement a “lower-for-longer” strategy? To answer this question, we analyze a series of optimal sustainable policy problems—indexed by the duration of reputational loss—in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates. We find that, even when the central bank lacks commitment, the central bank can still credibly keep the policy rate at the ELB for an extended period—though not as extended as under the optimal commitment policy—and meaningfully mitigate the adverse effects of the ELB constraint on economic activity.

An Integer L-shaped algorithm for vehicle routing problem with simultaneous delivery and stochastic pickup

This paper addresses an exact algorithm for vehicle routing problem with simultaneous pickup and delivery in which customer demands to be collected are stochastic. The problem is modeled as a two-stage stochastic programming problem with recourse, in which routing decisions are made based on known delivery demand and deterministic expected pickup demand in the first stage and recourse actions are made in the second stage when stochastic pickup quantities have been revealed. However, failures happen when the load of the vehicle is insufficient to meet the observed pickup demand of a customer. Three recourse policies are proposed to help deal with the failures to proceed with the routing decisions in the first stage. The Integer L-shaped algorithmic framework is used to solve this two-stage stochastic programming problems with recourse. Furthermore, effective lower bounding of the expected recourse cost of partial routes is designed for the three recourse policies, respectively. Computational experiments on the newly generated instances compare the performance of the Integer L-shaped algorithm under the three recourse policies, and the conclusion is validated via numerous simulations. The effectiveness of the proposed lower bounding functionals is confirmed through reduced optimality gaps and lower computing times.

Revisiting the New Keynesian policy paradoxes under QE

Standard New Keynesian models deliver puzzling results at the effective lower bound of short-term interest rates: greater price flexibility amplifies the fall in the output gap in response to adverse demand shocks; labour tax cuts are contractionary; the multiplier of wasteful government spending is large. These outcomes stem from a failure to characterise monetary policy correctly. Both analytically and numerically, we show that allowing the central bank to respond to inflation with quantitative easing can resolve all these paradoxes. In quantitative terms, mild adjustments to the central bank’s balance sheet are sufficient to obtain results more in line with conventional wisdom.

The term structure of macroeconomic risks at the effective lower bound

This paper proposes a new macro-finance model that solves the tension between tractability, flexibility in macroeconomic dynamics, and consistency of the term structures of treasury yields with the effective lower bound (ELB). I use the term structures of U.S. nominal and real treasury yields from 1990 to explore the interdependence between inflation expectations, volatility, and monetary policy at the ELB. The estimation reveals that real yields stay elevated during the ELB due to large premia and deflation fears, produced by a persistent shift in inflation dynamics, with low average inflation and heightened inflation volatility.

Testing the Effectiveness of Unconventional Monetary Policy in Japan and the United States

The effective lower bound (ELB) on a short term interest rate may not constrain a central bank's capacity to achieve its objectives if unconventional monetary policy (UMP) is powerful enough. We formalize this 'irrelevance hypothesis' using a dynamic stochastic general equilibrium model with UMP and test it empirically for the United States and Japan using a structural vector autoregressive model that includes variables subject to occasionally binding constraints. The hypothesis is strongly rejected for both countries. However, a comparison of the impulse responses to a monetary policy shock across regimes shows that UMP has had strong delayed effects in each country.

Achieving Two Policy Targets With One Policy Instrument: Heterogeneous Expectations, Countercyclical Fiscal Policy, and Macroeconomic Stabilization at the Effective Lower Bound

Achieving Two Policy Targets With One Policy Instrument: Heterogeneous Expectations, Countercyclical Fiscal Policy, and Macroeconomic Stabilization at the Effective Lower Bound

The open-economy ELB: Contractionary monetary easing and the trilemma

Contrary to Mundell's trilemma, we show that free capital mobility may prevent monetary policy from ensuring output stability even if the exchange rate is flexible due to the existence of an Effective Lower Bound. The ELB is an interest rate threshold below which monetary easing becomes contractionary because of adverse effects on credit supply. A tightening in global monetary and financial conditions increases the ELB and may force central banks to hike rates even though domestic economic activity contracts. We also show that the ELB gives rise to a novel inter-temporal trade-off for monetary policy and calls for using a broad range of policy tools to restore monetary transmission.

LINVER: The Linear Version of FRB/US

FRB/US, a large-scale, nonlinear macroeconomic model of the U.S., has been in use at the Federal Reserve Board for 25 years. For nearly as long, the FRB/US “project” has included a linear version of the model known as LINVER. A key reason that LINVER exists is the vast reduction in the computational costs that linearity confers when running experiments requiring large numbers of simulations under the assumption that expectations are model-consistent (MC). The public has been able to download FRB/US simulation code, documentation, and data from the Federal Reserve Board’s website since 2014. To further expand access to and understanding of the FRB/US project, a package devoted to LINVER is now available on the website. In this paper, we provide both a general introduction to LINVER and an overview of the contents and capabilities of its package. We review the ways that LINVER has been used in past research to study key policy issues; describe the package’s comprehensive set of programs for running simulations with MC expectations, with or without imposing the effective lower bound (ELB) on the federal funds rate and other nonlinear constraints; and illustrate how LINVER deterministic and stochastic simulations can be used to gauge the implications of the ELB for macroeconomic performance and to assess different strategies for mitigating its adverse effects.

Beyond the interest rate pass-through: monetary policy and banks interest rates since the effective lower bound

ABSTRACT We investigate whether ECB monetary policy influences the retail interest rates in the Euro Area when the policy rate reaches the effective lower bound. We estimate a panel Error Correction Model that accounts for potential heterogeneities in the transmission of monetary policy. The analysis disentangles alternative balance-sheet policies implemented by the ECB. We find that unconventional measures have influenced banking interest rates beyond the pass-through of the current and expected policy rate. These effects are driven by liquidity provisions and by the covered bond purchase programmes. Those policies have been effective in the core and in the peripheral countries; however, the effect of purchases of covered-bond has been stronger in the periphery.

Average Inflation Targeting in a Low-Rate Environment

One significant change in the US economy in the last 20 years is the trend decline in real interest rates that pushes the policy rate near the effective lower bound (ELB) and puts downward pressure on inflation. This environment leaves conventional monetary policy tools less effective in accommodating adverse shocks. To better achieve the Federal Reserve’s dual mandate at the ELB, the FOMC adopted a new framework called average inflation targeting (AIT). In this Commentary, I demonstrate that AIT is a better policy in a low-rate environment because of its ability to anchor inflation expectations, and I present possible implications of the flexible implementation of AIT.

A Relaxed and Bound Algorithm Based on Auxiliary Variables for Quadratically Constrained Quadratic Programming Problem

Quadratically constrained quadratic programs (QCQP), which often appear in engineering practice and management science, and other fields, are investigated in this paper. By introducing appropriate auxiliary variables, QCQP can be transformed into its equivalent problem (EP) with non-linear equality constraints. After these equality constraints are relaxed, a series of linear relaxation subproblems with auxiliary variables and bound constraints are generated, which can determine the effective lower bound of the global optimal value of QCQP. To enhance the compactness of sub-rectangles and improve the ability to remove sub-rectangles, two rectangle-reduction strategies are employed. Besides, two ϵ-subproblem deletion rules are introduced to improve the convergence speed of the algorithm. Therefore, a relaxation and bound algorithm based on auxiliary variables are proposed to solve QCQP. Numerical experiments show that this algorithm is effective and feasible.