Monetary Economics.

• Author: Nakamura, Emi
• Position: Program Report

For much of the last decade, policymakers in advanced economies have grappled with challenges resulting from the Great Recession of 2007-09 and sovereign debt problems in Europe. During this time, inflation was persistently below targets set by central banks in the United States, Europe, and Japan. As a consequence, a major focus of research and practice was how to further stimulate these economies through unconventional monetary policy and raise their rates of inflation toward target levels.

More recently, the global economic downturn and subsequent rebound associated with COVID-19 have shifted the focus of both research and practice. In 2021, advanced economies--and especially the United States--have experienced a substantial increase in inflation, to levels well above target. This has raised concerns about the reemergence of inflation that have been largely dormant for some time.

Alongside these macroeconomic developments, the field of monetary economics has been influenced by other societal changes, such as rising inequality, increasing concern about climate change, and the development of new technologies such as blockchains and cryptocurrencies.

Several strands of methodological and theoretical advances also have made a large imprint on the field of monetary economics over the past decade. On the empirical side, researchers have increasingly embraced new data sources, including high-frequency and cross-sectional data, and methods of identification. The increased use of forward guidance--statements by central banks about the future path of policy rates--has raised significant theoretical issues and resulted in a burst of innovative research. Also, the development of heterogeneous agent New Keynesian models--HANK models--has been important.

In this brief program report, we highlight several strands of innovative research on these issues, conducted by affiliates of the NBER's Monetary Economics Program.

Negative Nominal Interest Rates

Conventional wisdom has long held that nominal interest rates cannot fall below zero. The reason for this is that once nominal interest rates are negative, cash earns a higher return than lending. Who would deposit their money in a bank or purchase a Treasury bill when these assets earn less than simply holding cash? This "zero lower bound" on nominal interest rates clearly affected policy during the Great Recession. Many central banks quickly lowered interest rates to zero or very close to zero, and stopped at that point.

Over the past decade, this conventional wisdom has been challenged. It is costly to hold large amounts of cash. It is therefore not clear that negative interest rates will lead to the rush for cash that conventional wisdom suggests. In the mid-2010s, several European central banks as well as the Bank of Japan decided to test negative waters. Figure 1--taken from work by Mauricio Ulate--shows the evolution of policy rates in the Euro area, Denmark, Sweden, Switzerland, and Japan since 2010. (1) Switzerland and Denmark have ventured farthest into negative territory, with policy rates reaching -0.75 percent.

An important concern with negative nominal interest rates is how they affect bank profitability. If deposit rates do not fall below zero--because of bank concerns regarding depositor reactions to such a move--while lending rates and yields on other bank assets fall, negative nominal rates will potentially squeeze bank interest rate margins. Banks may react to this by not reducing lending rates or, if they do cut rates, reduced profits may adversely affect their net worth and therefore their ability to lend. Markus Brunnermeier and Yann Koby present a formal model that captures these...