Working Paper: CEPR ID: DP16050
Authors: Günter Coenen; Carlos Montes-Galdón; Frank Smets
Abstract: We study the incidence and severity of periods with a binding effective lower bound onnominal interest rates and the efficacy of three types of state-dependent policies—forwardguidance about the path of future interest rates, large-scale asset purchases and spending basedfiscal stimulus—in mitigating the detrimental consequences of the lower bound.Based on the ECB’s New Area-Wide Model of the euro area, our findings suggest that,if unaddressed, the lower bound can cause substantial macroeconomic distortions. In thenear term, forward guidance, if fully credible, is most powerful and can largely undothe distortions due to the lower bound. A combination of imperfectly credible forwardguidance, asset purchases and fiscal stimulus is almost equally effective, especially whenasset purchases enhance the credibility of the forward-guidance policy via a signallingeffect. In the long run, with an equilibrium real rate as low as zero, a combination of allthree policies is needed to materially reduce the distortions.
Keywords: effective lower bound; monetary policy; forward guidance; asset purchases; fiscal policy; euro area
JEL Codes: E31; E32; E37; E52; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fully credible forward guidance (E61) | macroeconomic distortions (E19) |
| imperfectly credible forward guidance + asset purchases + fiscal stimulus (E62) | macroeconomic distortions (E19) |
| asset purchases (G32) | credibility of forward guidance (E61) |
| forward guidance + asset purchases + fiscal stimulus (E62) | macroeconomic stability (E60) |
| strong forward guidance (E60) | outcomes close to unconstrained scenarios (C62) |
| weak forward guidance (E66) | less favorable outcomes (I14) |
| policy implementation (D78) | macroeconomic stability (E60) |