The breakdown of the money multiplier at the zero lower bound

Abstract

Unconventional monetary policy intends to influence the economy at the zero lower bound. However, this policy becomes less effective due to a diminishing money multiplier in a liquidity trap. We show that this creates an extreme low interest rate, low multiplier regime. This insight contributes to the literature, which shows there is uncertainty over the effects of unconventional monetary policy and the precise channel through which it works.

Keywords:

• monetary policy
• interest rates
• money multipliers

JEL Classification:

• E51
• E52

Notes

¹ We use the 3 months money market rate instead of the policy rate, because the market rate is a closer proxy of the short-term interest rate that effectively influences the behaviour of market participants.

² See Borio and Disyatat (2010) for a detailed description of the transmission channel.