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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Monetary policy when the nominal short-term interest rate is zero
James A. Clouse
Dale W. Henderson
Athanasios Orphanides
David H. Small
Peter A. Tinsley
Abstract

In an environment of low inflation, the Federal Reserve faces the risk that it has not provided enough monetary stimulus even when it has pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate has been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base that may stimulate aggregate demand by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act, The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and private-sector credit instruments (at least those that may be purchased by the Federal Reserve); unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, perhaps in some circumstances, the use of options.


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James A. Clouse & Dale W. Henderson & Athanasios Orphanides & David H. Small & Peter A. Tinsley, Monetary policy when the nominal short-term interest rate is zero, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2000-51, 2000.
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Keywords: Monetary policy ; Open market operations ; Liquidity (Economics)
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