1. Monetary Policy at the Zero Bound on Interest Rates
Seminar
Central Banking and Financial Stability
June 27th,2003, Riezlern
Claudia Grupe

2. Quantitative easing: Open-market operations
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
&Wieland
Svensson
Outline:
Fiscal stimulus
Quantitative easing: Open-market operations
The model by Orphanides and Wieland 1999:
Aggressive extension of the monetary base
Svensson: “The foolproof way“
Claudia Grupe

3. Fiscal stimulus Drawbacks: Fiscal Stimulus
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
&Wieland
Svensson
Fiscal stimulus
A broad-based tax cut might stimulate consumption and the price level.
Drawbacks:
Creation of future tax liabilities.
Germany: Maastricht criteria limit the space for fiscal operations.
Claudia Grupe

4. Open-market operations
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
&Wieland
Svensson
Open-market operations
Open-market operations are a central bank’s sales or purchases of government securities in the open-market.
How do they work when the interest rate is at zero?
Useful distinction:
Narrow Liquidity: Services provided by the medium of exchange allowing the public to economize on shopping time.
Broad Liquidity: Service yield provided by assets according to how easily they can be turned into cash.
Claudia Grupe

5. The central bank might purchase long term bonds from the public.
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
&Wieland
Svensson
Impossible to affect narrow liquidity under zero interest rates, but how about broad liquidity?
Long term bonds provide relatively little liquidity services per currency unit when interest rates are bounded to zero.
Public is likely to acquire assets yielding direct utility: money or productive services.
The central bank might purchase long term bonds from the public.
Claudia Grupe

6. Idea: Orphanides & Wieland Aggressive expansion of the monetary base
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
& Wieland
Svensson
Idea:
Aggressive expansion of the monetary base
in order to stimulate aggregate demand and inflation
by running a depreciation.
 Policy rule defined in terms of the monetary base, may also be carried out when nominal interest rates are constrained at zero.
Claudia Grupe

7. Drawbacks: Orphanides & Wieland Effect is at best very small,
Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
& Wieland
Svensson
Drawbacks:
Effect is at best very small,
rare empirical evidence.
Apparent weakness: An extension of the monetary base does not necessarily imply a rising inflation rate.
Open-market operations to be effective have to be large-scaled.
Claudia Grupe

8. Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
& Wieland
Svensson
Idea:
Introduction of an exchange rate peg at a substantially devalued exchange rate and announcement of a price level target path.
Announcement that when the price level target path has been reached, the peg will be abandoned.
 Raise in inflationary expectations.
Claudia Grupe

9. Central Banking at the zero bound on interest rates
Introduction
Fiscal
Stimulus
Open-market
Operations
Orphanides
& Wieland
Svensson
Drawbacks:
Exchange-rate oriented policies may resemble a “beggar-thy- neighbor”-strategy.
Might work less well for very large economies
Claudia Grupe