Misconceptions Regarding the Zero Lower Bound on Interest Rates

Bennett McCallum

Monetary and Economic Studies, 2006, vol. 24, issue S1, 13-26

Abstract: The paper reviews issues related to the zero lower bound (ZLB) on interest rates and argues that all of the following propositions are invalid: (1) in a ZLB situation, "shaping interest rate expectations is essentially the only tool that central bankers have" (Bernanke, Reinhart, and Sack [2004]); (2) fiscal policy actions such as "helicopter drops" are in theory more effective than monetary policy actions; (3) the prominent "foolproof way" policy rule of Svensson (2001, 2003) is applicable more generally?that is, even when exact uncovered interest parity holds?than the alternative exchange rate rule of McCallum (2000); (4) both of the exchange rate strategies described in (3) are open to the objection that they constitute "beggar-thy-neighbor" approaches; and (5) there is a significant danger of ZLB difficulties stemming from a " deflationary trap" type of equilibrium, as distinct from a "liquidity trap."

Keywords: Interest rates; Zero lower bound; Quantitative easing; Expectations; Deflation trap; Liquidity trap (search for similar items in EconPapers)
JEL-codes: E3 E52 F41 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ime:imemes:v:24:y:december:i:s1:p:13-26

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