Abstract

This paper presents a model with broad liquidity services to discuss the consequences of massive money injection in an economy with the zero interest rate bound. We incorporate Goodfriend’s (2000) idea of broad liquidity services into the model by allowing the amounts of bonds with various maturities held by a household to enter its utility function. We show that the satiation of money (or the zero marginal utility of money) is not a necessary condition for the one-period interest rate to reach the zero lower bound; instead, we present a weaker necessary condition that the marginal liquidity service provided by money coincides with the marginal liquidity service provided by the one-period bonds, both of which are not necessarily equal to zero. This result implies that massive money injection would have some influences on an equilibrium of the economy even if it does not alter the private sector’s expectations about future monetary policy. Our empirical results indicate that forward interest rates started to decline relative to the corresponding futures rates just after March 2001, when a quantitative monetary easing policy started by the Bank of Japan, and that the forward and futures spread has never closed until the policy ended in March 2006. We argue that these findings are not easy to explain by a model without broad liquidity services.

Introduction

Recent researches on the optimal monetary policy in an economy with the zero interest rate bound have found the importance of a central bank’s commitment about future monetary policy (Woodford (1999), Jung et al. (2005), Eggertsson and Woodford (2003) among others). In a usual environment, a central bank conducts monetary easing by lowering the current overnight interest rate through an additional injection of money to the market. However, this does not work well once the overnight interest rate reaches the zero lower bound. Further monetary easing in such a situation could be implemented only through central bank’s announcements about the future path of the overnight interest rate. Specifically, it has been shown that the optimal monetary policy rule is characterized by “history dependence” in the sense that a central bank commits itself to continuing monetary easing even after the economy returns to a normal situation.

2006.11

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