Identification at the Zero Lower Bound

TL;DR

This paper demonstrates how the Zero Lower Bound on interest rates can be used to identify the causal effects of monetary policy, including unconventional policies, through a simple testing method applied to U.S. data.

Contribution

It introduces a novel approach to identify and test the efficacy of unconventional monetary policies at the ZLB using a shadow rate and SVAR model.

Findings

Unconventional policies have a significant effect at the ZLB.

Unconventional policies are less effective than conventional ones.

Rejection of the null hypothesis that unconventional policies are ineffective.

Abstract

I show that the Zero Lower Bound (ZLB) on interest rates can be used to identify the causal effects of monetary policy. Identification depends on the extent to which the ZLB limits the efficacy of monetary policy. I propose a simple way to test the efficacy of unconventional policies, modelled via a `shadow rate'. I apply this method to U.S. monetary policy using a three-equation SVAR model of inflation, unemployment and the federal funds rate. I reject the null hypothesis that unconventional monetary policy has no effect at the ZLB, but find some evidence that it is not as effective as conventional monetary policy.