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Optimal Monetary Policy under Negative Interest Rate

Feng Dong () and Yi Wen ()

No 2017-19, Working Papers from Federal Reserve Bank of St. Louis

Abstract: In responding to the extremely weak global economy after the financial crisis in 2008, many industrial nations have been considering or have already implemented negative nominal interest rate policy. This situation raises two important questions for monetary theories: (i) Given the widely held doctrine of the zero lower bound on nominal interest rate, how is a negative interest rate (NIR) policy possible? (ii) Will NIR be effective in stimulating aggregate demand? (iii) Are there any new theoretical issues emerging under NIR policies? This article builds a model to show that (i) money injections can remain effective even when the nominal bank lending rate has reached zero or become negative; (ii) it is a good policy to keep the nominal interest rate as low as possible by purchasing government bonds with money; and (iii) the conventional wisdom on the notion of the liquidity trap and the Fisherian decomposition between the nominal and real interest rate can be invalid.

Keywords: Monetary Policy; Quantitative Easing; Liquidity Preference; Liquidity Trap; Banking; Money Demand (search for similar items in EconPapers)
JEL-codes: E12 E13 E31 E32 E41 E43 E51 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2017-05-16
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:2017-019

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DOI: 10.20955/wp.2017.019

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