Effectiveness of unconventional monetary policies in a low interest rate environment

BIS Working Papers  |  No 691  | 
19 January 2018



Was the lacklustre economic recovery due in part to the waning effectiveness of unconventional monetary policies (UMPs) amid low interest rates? Or was it due to the economy's lower sensitivity to interest rates? For answers, we look at experiences with monetary policy in the major advanced economies.


We contribute to monetary policy research in three ways. First, we show how a recently designed UMP model can be exploited to jointly test for changing UMP effectiveness and interest rate sensitivity. Second, we demonstrate the importance of accounting for bank lending behaviour in the monetary transmission mechanism. This captures the often overlooked pass-through from monetary policy to the lending rates that borrowers actually face. Third, we consider common UMP experiences across the major advanced economies.


The stimulative effect of UMPs has weakened over the past decade. But, there is little evidence that economies have become less interest rate-sensitive. What explains this finding? A fall in the estimated "natural" rate (ie short-run benchmark for the stance of monetary policy). The fall effectively sapped the stimulative power of lower policy rates and larger central bank balance sheets.

Although a fall in the "natural" rate is not a new result, our evidence points to a less conventional explanation. Monetary policy itself appears to be the culprit, via signalling and safe asset channels. Looking ahead, our findings point to an expected rise in the "natural" rate during the normalisation of monetary policy. That is, our model suggests that higher policy rates in the major advanced economies could coincide with an increase in estimated "natural" rates. If central banks place too little weight on this possibility, an overly procyclical monetary policy could result, and central banks could find themselves unwittingly falling progressively behind the curve.



Have unconventional monetary policies (UMPs) become less effective at stimulating economies in persistently low interest rate environments? This paper examines that question with a time-varying parameter VAR for the United States, the United Kingdom, the euro area and Japan. One advantage of our approach is the ability to measure an economy's evolving interest rate sensitivity during the post-GFC macroeconomy. Another advantage is the ability to capture time variation in the "natural", or steady state, rate of interest, which allows us to separate interest rate movements that are associated with changes in the stance of monetary policy from those that are not.

JEL classification: E43, E44, E52, E58

Keywords: lending rate, quantitative easing, time-varying parameter VAR model, unconventional monetary policy