Princeton University

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 analogous to the federal funds rate in the United States) has been within 50 basis points of zero since October 1995, and it has been essentially equal to zero for most of the past four years (fig-ure 1). Thus the Bank of Japan has had little room to further reduce short-term nominal interest rates in all that time. Meanwhile Japan’s growth has remained anemic, 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 mone-tary base has also seemed to do little to stimulate demand under these cir-cumstances: as figure 1 also shows, the monetary base is now more than twice as large, relative to GDP, as it was in the early 1990s. In the United States, meanwhile, the federal funds rate has now been reduced to only 1 percent, and signs of recovery remain exceedingly frag-ile. This has led many to wonder if this country might not also soon find itself in a situation where interest rate policy is no longer available as