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Monetary Policy and the Zero Bound on Nominal Interest Rates

The recent financial crisis and global economic slowdown have renewed interest in monetary policy options when the policy interest rate is at or near zero. This article examines how different monetary policy frameworks might help to lower the risk and economic cost of such a scenario. The authors present an analytical framework for examining monetary policy at the zero bound, particularly the role of inflation expectations in lowering the real interest rate. The influence of inflation targeting on inflation expectations and how forward guidance or a conditional commitment to future monetary policy may augment traditional monetary policy actions are also examined. The authors then examine recent research on the efficacy of price-level targeting (PLT) at the zero bound, which demonstrates that a credible PLT framework can reduce the likelihood of hitting the zero bound and lessen the economic costs of remaining there. PLT is also found to offer stabilization advantages in "normal" times, although these hinge critically on the degree of credibility of the PLT regime.

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Article provided by Bank of Canada in its journal Bank of Canada Review.

Volume (Year): 2010 (2010)
Issue (Month): Summer ()
Pages: 3-10

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Handle: RePEc:bca:bcarev:v:2010:y:2010:i:summer10:p:3-11
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