Zero Lower Bound, Negative Interest Rates & Choices for Monetary Policy in the UK

Abstract

In the context of debate around Zero Lower Bound (ZLB) on the nominal interest rates and negative interest rates as a monetary policy option this study has a) critically discussed the policy instruments available in the toolbox when the monetary policy is at ZLB, b) has analysed the notion and implications of real policy (Bank) rates for the British economy in Pre and Post ZLB world. In so doing, first, we drew on the idea of negative interest rates postulated by Gesell and discussed by Keynes and Dow. Second, we investigated the impact of real policy rates on UK economy by using a Time-Varying Structural Vector Auto-regressive (TVSVAR) Model. Employing the data on real GDP growth, unemployment, inflation and real policy rates from January 1989 to September 2016 in a framework where the sources of time variation were both the coefficients and variance-covariance matrix of the innovations. It was found that the real rates have significant implication for the real growth, labour market and price stability even when in the nominal sense the monetary policy was constrained at the ZLB. The study also considered the strategy of allowing a discrete break in the data and completely focusing the Post-Global Financial Crisis and ZLB epoch. It showed that the real rates effectiveness did not diminish which has important implications in terms of policy setting and allowing for the other measures and perhaps more emphasis on coordination with fiscal policy than pushing on negative rates.

Keywords: Monetary Policy, Zero Lower Bound, Quantitative Easing, Policy Coordination, Negative Interest Rates, TVSVAR Model l

JEL Classification: C11, E23, E31, E43