Monetary Policy When the Nominal Short-Term Interest Rate is Zero

84 Pages Posted: 7 Dec 2000

See all articles by James A. Clouse

James A. Clouse

Board of Governors of the Federal Reserve System - Monetary and Financial Market Analysis Section

Dale W. Henderson

Federal Reserve Board

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management

David H. Small

Federal Reserve Board - Monetary Studies Section

Peter A. Tinsley

George Washington University; Birkbeck College, Univ. of London

Date Written: November 2000

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

JEL Classification: E52

Suggested Citation

Clouse, James A. and Henderson, Dale W. and Orphanides, Athanasios and Small, David H. and Tinsley, Peter A., Monetary Policy When the Nominal Short-Term Interest Rate is Zero (November 2000). FEDS Working Paper No. 00-51. Available at SSRN: https://ssrn.com/abstract=253068 or http://dx.doi.org/10.2139/ssrn.253068

James A. Clouse

Board of Governors of the Federal Reserve System - Monetary and Financial Market Analysis Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Dale W. Henderson

Federal Reserve Board ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2343 (Phone)
202-736-5638 (Fax)

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

David H. Small (Contact Author)

Federal Reserve Board - Monetary Studies Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Peter A. Tinsley

George Washington University ( email )

710 21st Street NW
Washington, DC 20052
United States

Birkbeck College, Univ. of London

Malet Street
London, WC1E 7HX
United Kingdom

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