Macroeconomic Stabilisation and Monetary Policy Effectiveness in a Low-Interest-Rate Environment

39 Pages Posted: 22 Sep 2021

See all articles by Günter Coenen

Günter Coenen

European Central Bank (ECB)

Carlos Montes-Galdon

European Central Bank

Sebastian Schmidt

European Central Bank (ECB)

Multiple version iconThere are 3 versions of this paper

Date Written: July 2021

Abstract

The secular decline in the equilibrium real interest rate observed over the past decades has materially limited the room for policy-rate reductions in recessions, and has led to a marked increase in the incidence of episodes where policy rates are likely to be at, or near, the effective lower bound on nominal interest rates. Using the ECB's New Area-Wide Model, we show that, if unaddressed, the effective lower bound can cause substantial costs in terms of worsened macroeconomic performance, as reflected in negative biases in inflation and economic activity, as well as heightened macroeconomic volatility. These costs can be mitigated by the use of nonstandard instruments, notably the joint use of interest-rate forward guidance and large-scale asset purchases. When considering alternatives to inflation targeting, we find that make-up strategies such as price-level targeting and average-inflation targeting can, if they are well-understood by the private sector, largely undo the negative biases and heightened volatility induced by the effective lower bound.

Keywords: asset purchases, effective lower bound, forward guidance, make-up strategies, monetary policy

JEL Classification: E31, E32, E37, E52, E58

Suggested Citation

Coenen, Günter and Montes-Galdon, Carlos and Schmidt, Sebastian, Macroeconomic Stabilisation and Monetary Policy Effectiveness in a Low-Interest-Rate Environment (July 2021). Available at SSRN: https://ssrn.com/abstract=3928682

Günter Coenen (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7887 (Phone)
+49 69 1344 6575 (Fax)

Carlos Montes-Galdon

European Central Bank ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Sebastian Schmidt

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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