Monetary Policy When the Nominal Short-Term Interest Rate is Zero

In an environment of low inflation, the Federal Reserve faces the risk that real interest rates could remain elevated and that it was not providing enough monetary stimulus even though it had pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate had 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 a#ecting 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 purchase...