Location of Repository

Monetary Policy and the Term Structure of Interest Rates When Short-Term Rates Are Close to Zero

By Shigeru Iwata


The zero lower bound on nominal interest rates can affect the effectiveness of monetary policy potentially in two ways. First, it limits the size of a change in the policy interest rate when trying to loosen money. For example, when the nominal rate is 0.5 percent, it obviously cannot be cut by more than 0.5 percent. Second, it may alter the mechanism of how a movement of the policy rate drives market rates of longer maturities. This paper is an attempt to investigate the latter issue, and, in particular, to empirically examine the effect of monetary policy on the term structure of interest rates when nominal short-term rates are close to zero, using Japanese data in the 1990s and early 2000s. We found that when the policy short rate is already zero but longer rates are still positive in the zero interest rate period, an expansionary monetary policy still works through the conventional interest rate channel by pushing down longer rates, although the effect is much weakened relative to the normal time. When the longer rates are already lowered to some level, however (for example, the 10-year bond rate went down to the level as low as 1.5 percent during the quantitative easing period of 2001-06), a further expansion of the monetary base by increasing excess reserves of banks appears to have little effect in lowering longer-term rates.Zero interest rates; Yield curve; Liquidity trap

OAI identifier:

Suggested articles



  1. (2004). A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy,” working paper, Federal Reserve Bank of San Francisco,
  2. (2007). a n d , “Economic Determinants of the Nominal Treasury Yield Curve,”
  3. (2004). a n d , “Policy Options in a Liquidity Trap,”
  4. (2003). A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables,”
  5. (2004). Conducting Monetary Policy at Very Low Short-Term Interest Rates,”
  6. (1995). Credit and (Other) Transmission Processes: A Monetarist Perspective,”
  7. (2006). Estimating Monetary Policy Effects When Interest Rates Are Close to Zero,”
  8. (1958). Estimation of Relationships for Limited Dependent Variables,”
  9. (2001). Further Monetary Easing Policies under the Non-negativity Constraints of Nominal Interest Rates:
  10. (1991). How Should Long-Term Monetary Policy Be Determined?”
  11. (2003). How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible,”
  12. (1996). Impulse Response Analysis in Nonlinear Multivariate Models,”
  13. (1998). It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,”
  14. (1999). Japanese Monetary Policy: A Quantity Theory Perspective,” Economic Quarterly, 85, Federal Reserve Bank of Richmond,
  15. (1999). Liquidity Traps: How to Avoid Them and How to Escape Them,”
  16. (2004). Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment,”
  17. (2006). Monetary Policy and the Term Structure of Interest Rates in
  18. (2006). Monetary Policy and the Yield Curve at Zero Interest: The MacroFinance Model of Interest Rates as Options,” Bank of Japan Working Paper No. 06-E-16, Bank of Japan,
  19. (1999). Monetary Policy Shocks: What Have We Learned and to What End?” Handbook of Macroeconomics,
  20. (1997). Monetary Policy When Interest Rates Are Bounded at
  21. (2001). n flation Targeting and the Liquidity Trap,”
  22. (2000). Nonlinear Impulse Response Functions,”
  23. (2001). Policy and the Term Structure of Interest Rates When Short-Term Rates Are Close to Zero Svensson, Lars E. O., “The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a
  24. (2002). Policy Duration Effect under the Zero Interest Rate Policy in 1999–2000:
  25. (2002). Preventing Deflation: Lessons from
  26. (1998). Price Stability and Monetary Effectiveness When Nominal Interest Rates Are Bounded at Zero,” Finance and Economics Discussion Paper No. 35, Federal Reserve Board,
  27. (1998). Staggered Price Setting and the Zero Bound on Nominal Interest Rates,” Economic Quarterly, Federal Reserve Bank of
  28. (2002). The Effects of Monetary Policy in
  29. (2005). The Effects of the Bank of Japan’s Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach,” Bank of Japan Working Paper No. 05-E-6, Bank of Japan,
  30. (2007). The Expectation Theory Works for Monetary Policy Shocks,”
  31. (2006). The Expectations Hypothesis of the Term Structure When Interest Rates Are Close to Zero,”
  32. (2004). The Term Structure of Interest Rates and Monetary Policy during a Zero Interest Rate Period,”
  33. (2000). Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates,”
  34. (2000). Three Lessons for Monetary Policy in a Low Inflation Era,”
  35. (2005). What Do You Expect? Imperfect Policy Credibility and
  36. (1990). What Does the Term Structure Tell Us about Future Inflation?”
  37. (2005). Zero Kinri tono Tatakai (Fighting against Zero Interest Rates), Nihon Keizai Shimbunsha,

To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.