Zero Rates and Zero Benefits?

Abstract: Ever since the Great Recession in 2008, the effectiveness of monetary policy has been increasingly debated. Central banks in modern economies were forced to find new ways of conducting expansionary monetary policy beyond conventional methods, most notably through quantitative easing and forward guidance, as they were at, or very close to, the zero lower bound of nominal interest rates. However, even with these new ways to stimulate the economy, the inflation has not been responding proportionally and has almost persistently remained stuck below the target. Today, subsequent to more than a decade of almost constant expansionary monetary policy to an under-shooting of the inflation target, household debt has been steadily increasing in many countries. This has raised questions about the role that household debt plays in determining the effectiveness of monetary policy. Using a SVAR model approach with data from Sweden and the US, this paper aims to explore the effectiveness of (unconventional) monetary policy conditional on household debt. By using alternative measures of policy rates to reflect the new realities of modern monetary policy, we show that high debt can have a detrimental effect on the effectiveness of monetary policy.