Using the Zero Lower Bound to Identify Monetary Policy Effects

Summary

This paper explains how the interest rate zero lower bound can help identify the causal effects of monetary policy. The central idea is that the bound restricts conventional rate cuts, so the degree to which policy still affects the economy at the bound provides evidence about the efficacy of unconventional measures. The author proposes a test that represents unconventional policy with a shadow interest rate and applies it to a three-equation structural vector autoregression covering inflation, unemployment, and the federal funds rate in the United States.

The reported results reject the hypothesis that unconventional policy has no effect at the lower bound, while suggesting that it may be less effective than conventional policy. The document provides a macroeconomic identification method and an empirical application, rather than a trading strategy or market-timing rule. Its conclusions depend on the model specification and on how the shadow rate captures unconventional policy; the short description does not provide detailed estimates or robustness checks.

Key ideas

• The zero lower bound can provide variation for identifying monetary policy effects.
• A shadow rate offers a way to represent unconventional policy in an empirical test.
• The application uses inflation, unemployment, and the federal funds rate in a structural VAR.
• The reported evidence finds an effect from unconventional policy but suggests reduced efficacy relative to conventional policy.

Tags

# Identification at the Zero Lower Bound


# Identification at the Zero Lower Bound









I show that the Zero Lower Bound (ZLB) on interest rates can be used to identify the causal effects of monetary policy. Identification depends on the extent to which the ZLB limits the efficacy of monetary policy. I propose a simple way to test the efficacy of unconventional policies, modelled via a `shadow rate'. I apply this method to U.S. monetary policy using a three-equation SVAR model of inflation, unemployment and the federal funds rate. I reject the null hypothesis that unconventional monetary policy has no effect at the ZLB, but find some evidence that it is not as effective as conventional monetary policy.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.