Conventional and unconventional monetary policy

The authors extend a standard New Keynesian model to incorporate heterogeneity in spending opportunities and two sources of (potentially time-varying) credit spreads and to allow a role for the central bank's balance sheet in equilibrium determination. They use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions, and to consider additional dimensions of central bank policy - variations in the size and composition of the central bank's balance sheet and payment of interest on reserves - alongside the traditional question of the proper choice of setting an operating target for an overnight policy rate. The authors also give particular attention to the special problems that arise when the policy rate reaches the zero lower bound. They show that it is possible within a single unified framework to identify the criteria for policy to be optimal along each dimension. The suggested policy prescriptions apply equally well when financial markets work efficiently as when they are substantially disrupted and interest rate policy is constrained by the zero lower bound.