Unconventional Monetary Policy Under Zero Lower Bound: Theory And The Fed Practice

In2008, the collapse of a series of major U.S. financial institutions marked that the subprime mortgage crisis had become a serious financial crisis, which quickly spread to many countries and regions in the world. The global economy had got into recession. In order to prevent the economic situation continuing to deteriorate and stimulate the economy, the world’s major economies kept lowering the nominal short-term interest rates until the zero approximation, facing with the constraint of zero interest rate floor. When nominal interest rates approaching zero, the central bank can not use conventional interest rate monetary tools to regulate the liquidity and can only take other unconventional monetary policy instruments to stimulate the economy. The study is based on the United States’s unconventional monetary policy practice in financial crisis, focusing on unconventional monetary policy options under the zero interest rate and its transmission mechanism and effect.The paper first reviewed the relevant literature on the meaning of the zero lower bound, summarizing the empirical analysis of the theoretical research and effectiveness of unconventional monetary policy under zero interest rate. From a theoretical point of view, the paper expounded the choice of unconventional monetary policy under the zero lower bound and policy objectives and the transmission mechanism. Then the paper describes the conventional and unconventional monetary policy practice implemented by the Federal Reserve during the financial crisis and discussed the effectiveness of the Fed’s unconventional monetary policy. Firstly, using the event study analysis, the paper studies the effectiveness of the policy communication and commitment. Then the paper examines the effectiveness of the Federal Reserve’s Credit and Liquidity Programs and Large-Scale Asset Purchases to stabilize financial market. Lastly, the paper tests the impact on prices and output that through the expansion of the Federal Reserve’s balance sheet. The analysis results show that the Fed’s unconventional monetary policy could ease the liquidity crunch of the financial market situation, boost market confidence and stimulate the economic recovery. However, the authority could not ignore the risks and problems of unconventional monetary policy.