Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit

Abstract

We simulate the FRB/US model and a number of statistical models to quantify some of the risks stemming from the effective lower bound (ELB) on the federal funds rate and to assess the efficacy of adjustments to the federal funds rate target, balance sheet policies, and forward guidance to provide monetary policy accommodation in the event of a recession. Over the next decade, our simulations imply a roughly 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. We also find that forward guidance and balance sheet polices of the kinds used in response to the Global Financial Crisis are modestly effective in speeding up the labor market recovery and return of inflation to 2 percent following an economic slump. However, these policies have only small effects in limiting the initial rise in the unemployment rate during a recession because of transmission lags. As with any model-based analysis, we also discuss a number of caveats regarding our results.

Effects of State‐Dependent Forward Guidance, Large‐Scale Asset Purchases, and Fiscal Stimulus in a Low‐Interest‐Rate Environment

“…These rules imply a change in the monetary policy framework, which we do not contemplate in this paper. Similarly, we do not consider threshold-based rules (Coenen and Warne 2014, Boneva, Harrison, and Waldron 2018, Chung et al 2019, which rely on an alternative mechanism to induce low-for-longer policy prescriptions. environment with structurally low interest rates where the lower bound is expected to be binding more frequently and for longer periods of time.…”

“…In so doing, the paper contributes to the literature on the conduct and efficacy of monetary policy at the lower bound, including the recent papers by Reifschneider (2016), Kiley and Roberts (2017), Kiley (2018) and Chung et al. (2019), which however all focus on the policies of the Federal Reserve and the U.S. economy. Our paper adds to this literature by considering the euro area economy and by also examining the role of expansionary fiscal policy as an additional stabilization instrument when the nominal interest rate has fallen to the lower bound, as called for, among others, by Blanchard (2019), Eichenbaum (2019), and Rachel and Summers (2019).…”

“…2 Against this background, our paper studies quantitatively the effects of forward guidance and large-scale asset purchases in a low-interest-rate environment in which the ability of monetary policy to stave off recessionary and deflationary shocks by adjusting its standard interest-rate instrument is impaired because of the effective lower bound. In so doing, the paper contributes to the literature on the conduct and efficacy of monetary policy at the lower bound, including the recent papers by Reifschneider (2016), Kiley and Roberts (2017), Kiley (2018) and Chung et al (2019), which however all focus on the policies of the Federal Reserve and the U.S. economy. 3 Our paper adds to this literature by considering the euro area economy and by also examining the role of expansionary fiscal policy as an additional stabilization instrument when the nominal interest rate has fallen to the lower bound, as 1.…”

“…See Hartmann and Smets (2018) and Rostagno et al (2019) for an account of the experience with the implementation of the ECB's asset-purchase program and its interaction with other nonstandard policies, including the ECB's forward guidance about the likely path of its key policy rates. For an assessment of the respective Federal Reserve policies, see Engen, Laubach, and Reifschneider (2015), Chung et al (2019), and Sims and Wu (2019).…”