Keywords: Zero interest-rate bound, liquidity trap, Great Depression, Japan.
Abstract: The experience of the U.S. economy during the mid-1930s, when short-term nominal interest
rates were continuously close to zero, is sometimes taken as evidence that monetary
policy was ineffective and the economy was in a "liquidity trap." Close examination of the
historical policy record for the period indicates that the evidence does not support such
assertions. The incomplete and erratic recovery from the Great Depression can be traced to
a failure to pursue consistently expansionary policy resulting from an incorrect understanding
of monetary policy in an environment of very low short-term nominal interest rates.
Commonalities with the Japanese experience during the late 1990s and the inadequacy
of short-term interest rates as indicators of the stance of monetary policy are discussed,
and a robust operating procedure for implementing monetary policy in a low interest rate
environment by adjusting the maturity of targeted interest rate instruments is described.
Full paper (243 KB PDF)
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Last update: January 28, 2004