2003), “The Zero Bound on Interest Rates and Optimal Monetary Policy

The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. The consequences for the proper conduct of monetary policy of the existence of a lower bound of zero for overnight nominal interest rates has recently become a topic of lively interest. In Japan, the call rate (the overnight cash rate that is analogous to the federal funds rate in the U.S.) has been within 50 basis points of zero since October 1995, so that little room for further reductions in short-term nominal interest rates has existed since that time, and has been essentially equal to zero for most of the past four years. (See Figure 1 below.) At the same time, growth has remained anemic in Japan over this period, and prices have continued to fall, suggesting a need for monetary stimulus. Yet the usual remedy — lower short-term nominal interest rates — is plainly unavailable. Vigorous expansion of the monetary base (which, as shown in the figure, is now more than twice as large, relative to GDP, as in the early 1990s) has also seemed to do little to stimulate demand under these circumstances. The fact that the federal funds rate has now been reduced to only 1.25 percent in th