Monetary Policy at the Zero Bound

The main conclusion of the paper is that – even if bank lending to the private sector is falling (and destroying money balances) at a zero short-term interest rate – the monetary authorities can always increase the quantity of money (broadly defined to include all bank deposits) without limit by means of debt market operations. Such operations are to be distinguished from more conventional money market operations. Assuming – in line with standard theory – that equilibrium nominal national income increases by the same percentage as the quantity of money, debt market operations are available at all times to pre-empt a downward debt-deflationary spiral.The paper differentiates debt market operations from money market operations, and a broad liquidity trap (in which increases in the quantity of money, broadly defined, do not reduce the long bond yield because of the infinite elasticity of non-banks’ demand to hold money) from a narrow liquidity trap (in which increases in the monetary base do not boost the quantity of money, because banks behave as if their demand for base were infinitely elastic). Keynes analysed the broad liquidity trap in The General Theory.