(Un)conventional Policy and the Effective Lower Bound
43 Pages Posted: 15 Oct 2018
Date Written: October 12, 2018
We study the optimal combination of conventional (interest rates) and unconventional (credit easing) monetary policy in a model where agency costs generate a spread between deposit and lending rates. We show that unconventional measures can be a powerful substitute for interest rate policy in the face of certain financial shocks. Such measures help shield the real economy from the deterioration in financial conditions and warrant smaller reductions in interest rates. They therefore lower the likelihood of hitting the lower bound constraint. The alternative option to cut interest rates more deeply and avoid deploying unconventional measures is sub-optimal, as it would induce unnecessarily large changes in savers’ intertemporal consumption patterns.
Keywords: optimal monetary policy, unconventional policies, zero-lower bound, asymmetric information
JEL Classification: E44, E52, E61
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