Keywords: Zero bound, term structure of interest rates, monetary policy, deflation
Abstract: Nominal short term interest rates have been low in the United
States, so low that some have wondered whether the federal funds
rate is likely to hit its lower bound at 0 percent. Such a
scenario, which some economists have called the liquidity trap,
would imply that the Federal Reserve could no longer lower
short-term interest rates to counter any deflationary tendencies in
the economy. In this paper, I use an affine term structure model to
infer what interest rates tell us about the probability, as assessed
by financial market participants, of such an event taking place. I
also examine whether U.S. short-term rates have been low enough to
distort the shape of the yield curve.
Full paper (242 KB PDF)
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Last update: September 3, 2003