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Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit

Author

Listed:
  • Hess Chung

    (Board of Governors of the Federal Reserve System)

  • Etienne Gagnon

    (Board of Governors of the Federal Reserve System)

  • Taisuke Nakata

    (University of Tokyo)

  • Matthias Paustian

    (Board of Governors of the Federal Reserve System)

  • Bernd Schlusche

    (Board of Governors of the Federal Reserve System)

  • James Trevino

    (Board of Governors of the Federal Reserve System)

  • Diego Vilán

    (Board of Governors of the Federal Reserve System)

  • Wei Zheng

    (Visa Inc.)

Abstract

We simulate the FRB/US model and a number of statistical models to quantify some of the risks stemming from the effective lower bound (ELB) on the federal funds rate and to assess the efficacy of adjustments to the federal funds rate target, balance sheet policies, and forward guidance to provide monetary policy accommodation in the event of a recession. Over the next decade, our simulations imply a roughly 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. We also find that forward guidance and balance sheet polices of the kinds used in response to the Global Financial Crisis are modestly effective in speeding up the labor market recovery and return of inflation to 2 percent following an economic slump. However, these policies have only small effects in limiting the initial rise in the unemployment rate during a recession because of transmission lags. As with any model-based analysis, we also discuss a number of caveats regarding our results.

Suggested Citation

  • Hess Chung & Etienne Gagnon & Taisuke Nakata & Matthias Paustian & Bernd Schlusche & James Trevino & Diego Vilán & Wei Zheng, 2020. "Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit," CARF F-Series CARF-F-483, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    • Handle: RePEc:cfi:fseres:cf483
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    1. Philippe Andrade & Jordi Gali & Herve Le Bihan & Julien Matheron, 2019. "The Optimal Inflation Target and the Natural Rate of Interest," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 50(2 (Fall)), pages 173-255.
    2. Link, Thomas, 2019. "Optimal timing of calling in large-denomination banknotes under natural rate uncertainty," DICE Discussion Papers 327, Heinrich Heine University Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).

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