from the Chicago Fed
–this post authored by Jonas Fisher, Francois Gourio, and Spencer Krane
There has been a growing consensus that a lower rate of potential economic growth in the U.S. and greater international demand for U.S. assets will result in a lower real interest rate in the long run.
In response to the massive challenges presented by the global financial crisis, in late 2007 the Federal Open Market Committee (FOMC) began a series of large reductions in its traditional policy tool, the overnight interest rate in the federal funds market. By December 2008 the Committee had lowered the target to its effective lower bound (ELB) of 0 to 25 basis points.
Later, in an attempt to provide additional monetary stimulus, the FOMC implemented nontraditional policy tools, such as large-scale asset purchases and forward guidance about how long the fed funds rate would stay at very low levels.
Evans, Fisher, Gourio, and Krane (2015) (EFGK) argued that if these nontraditional tools are imperfect substitutes for conventional policy, then when interest rates are near the ELB, monetary policy should contain an element of precautionary or risk-management behavior.2 If there is a meaningful risk that future shocks to the economy will leave the central bank constrained by the ELB, then it should conduct looser interest rate policy today than otherwise. They provided two rationales for this conclusion. Looser policy today could preemptively reduce the odds of being constrained by the ELB in the future. It could also offset the depressing effects on output and inflation today of households and firms looking forward to the possibility of the central bank being constrained by the ELB in the future. The optimal interest rate path thus falls below the level one would set for the target rate in the absence of uncertainty. Furthermore, the greater the uncertainty surrounding the possibility of the central bank being constrained by the ELB, the looser the optimal policy setting should be.
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Source
http://app.frbcommunications.org/e/er?s=1064&lid=4656 &elqTrackId=226fded8b7c242c19b19b3039d67201c &elq=db81e6dbb05e4f218bd3f07af901b652 &elqaid=11784&elqat=1
