Losing traction? The real effects of monetary policy when interest rates are low

35 Pages Posted: 29 Mar 2022

See all articles by Rashad Ahmed

Rashad Ahmed

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Claudio E. V. Borio

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

Piti Disyatat

Puey Ungphakorn Institute for Economic Research, Bank of Thailand

Boris Hofmann

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

Date Written: November 25, 2021

Abstract

Are there limits to how far reductions in interest rates can boost aggregate demand?
In particular, as interest rates fall to very low levels, does the effectiveness of monetary
policy in boosting the economy wane? We provide evidence consistent with this
hypothesis. Based on a panel of 18 advanced countries starting in 1985, we find that
monetary transmission to economic activity is substantially weaker when interest
rates are low. The results hold even when controlling for potential confounding non-linearities associated with debt levels and the business cycle as well as for the trend
decline in equilibrium interest rates. We also find evidence that the effectiveness of
monetary policy wanes the longer interest rates stay low. These findings suggest that
the observed flattening of the Phillips curve has gone hand in hand with a
corresponding steepening of the IS curve. Monetary policy trade-offs may have
become more challenging.

Keywords: Monetary policy, low interest rates, monetary transmission mechanism

JEL Classification: E20, E52, E58

Suggested Citation

Ahmed, Rashad and Borio, Claudio E.V. and Disyatat, Piti and Hofmann, Boris, Losing traction? The real effects of monetary policy when interest rates are low (November 25, 2021). Available at SSRN: https://ssrn.com/abstract=4051566 or http://dx.doi.org/10.2139/ssrn.4051566

Rashad Ahmed

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street SW
Washington, DC 20219
United States

Claudio E.V. Borio

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

CH-4002 Basel, Basel-Stadt
Switzerland

Piti Disyatat

Puey Ungphakorn Institute for Economic Research, Bank of Thailand ( email )

273 Samsen Road
Bangkhunphrom, Bangkok 10200
Thailand

Boris Hofmann (Contact Author)

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

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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