Is Monetary Policy Less Effective When Interest Rates are Persistently Low?

33 Pages Posted: 29 Apr 2017

See all articles by Claudio E. V. Borio

Claudio E. V. Borio

Bank for International Settlements (BIS) - Research and Policy Analysis

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: April 2017

Abstract

Is monetary policy less effective in boosting aggregate demand and output during periods of persistently low interest rates? This paper reviews the reasons why this might be the case and the corresponding empirical evidence. Transmission could be weaker for two main reasons: (i) headwinds, which would typically arise in the wake of balance sheet recessions, when interest rates are low; and (ii) inherent non-linearities, which would kick in when interest rates are persistently low and would dampen their impact on spending. Our review of the evidence suggests that headwinds during the recovery from balance-sheet recessions tend to reduce monetary policy effectiveness. At the same time, there is also evidence of inherent non-linearities. That said, disentangling the two types of effect is very hard, not least given the limited extant work on this issue. In addition, there appears to be an independent role for nominal rates in the transmission process, regardless of the level of real (inflation-adjusted) rates.

Keywords: monetary policy, low interest rates, balance-sheet recession, monetary transmission

JEL Classification: E43, E52

Suggested Citation

Borio, Claudio E.V. and Hofmann, Boris, Is Monetary Policy Less Effective When Interest Rates are Persistently Low? (April 2017). BIS Working Paper No. 628. Available at SSRN: https://ssrn.com/abstract=2957961

Claudio E.V. Borio (Contact Author)

Bank for International Settlements (BIS) - Research and Policy Analysis ( email )

CH-4002 Basel, Basel-Stadt
Switzerland

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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