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Chapter 26: Q.3 (page 690)

How can the interest rate channel still function when short term nominal interest rates are at the zero lower bound?

Short Answer

Expert verified

When short-term nominal interest rates are at the zero lower bound, the interest rate channel continues to function.

Step by step solution

01

Step 1. Concept of nominal interest 

Interest rate channels can still function at zero lower limit short-term nominal interest rates if the central bank commits to future accelerated monetary policy.

02

Step 2. Explanation

When the central bank commits to future accelerating monetary policy, interest rate channels can still function at zero lower bound short-term nominal interest rates. Even if nominal interest rates are at zero, this future accelerating monetary policy will boost projected inflation, and therefore interest rates will fall.

As a result, by lowering real interest rates, the interest rate channel can still operate at zero lower limit nominal interest rates.

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Most popular questions from this chapter

Describe an advantage and a disadvantage of the fact that monetary policy has so many different channels through which it can operate.

Why does the credit view imply that monetary policy has a greater effect on small businesses than on large firms?

A "rate cycle" is a period of monetary policy during which the federal funds rate moves from its low point toward its high point, or vice versa, in response to business cycle conditions. Go to the St. Louis Federal Reserve FRED database, and find data on the federal funds rate (FEDFUNDS), real business fixed investment (PNFIC96), real residential investment (PRFIC96), and consumer durable expenditures (PCDGCC96). Use the frequency setting to convert the federal funds rate data to "quarterly," and download the data.

a. When did the last rate cycle begin and end? (Note: If a rate cycle is currently in progress, use the current period as the end.) Is this rate cycle a contractionary or an expansionary rate cycle?

b. Calculate the percentage change in business fixed investment, residential (housing) investment, and consumer durable expenditures over this rate cycle.

c. Based on your answers to parts (a) and (b), how effective was the traditional interest rate channel of monetary policy over this rate cycle?

During and after the global financial crisis, the Fed provided banks with large amounts of liquidity. Banks' excess reserves increased sharply, while credit extended to households and firms decreased sharply. Comment on the effectiveness of the bank lending channel during this period.

"A decrease in short-term nominal interest rates necessarily implies a stance of monetary easing." Is this statement true, false, or uncertain? Explain your answer.
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