The Zero Bound on Nominal Interest Rates: How Important Is It?

Abstract

This paper surveys the literature on the zero bound on the nominal interest rate. It addresses questions ranging from the conditions under which the zero bound on the nominal interest rate might occur to policy options to avoid or use to exit from such a situation. We discuss literature that examines historical and country evidence, and literature that uses models to generate evidence on this question. There seems to be a consensus that the probability of encountering the zero bound is relatively low, especially if the inflation target established for the monetary authority is 2 per cent or more. There is some indication in the model work that the likelihood of encountering the zero bound increases at an increasing rate for lower inflation targets. Various caveats apply to drawing conclusions for Canada from the papers we surveyed, among them the paucity of historical experience where a zero bound has occurred, the risk of making inferences using data (or parameters) from different monetary regimes, the relatively few studies using Canadian data, and the weight to give to credibility.

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