Unconventional monetary policy: introduction

The world’s four major central banks have turned to new forms of monetary policy to support demand during the Global Financial Crisis.¹ The conventional policy instrument of overnight interest rates was reduced to close to zero per cent within eighteen months of the crisis.² This presents a problem of providing further stimulus by lowering interest rates; if rates turn negative then depositors always have the option of holding wealth in cash at a zero interest rate. The option of holding cash is thought to create an effective floor on interest rates known as the zero lower bound (ZLB). Central banks have had to find new ways of deploying monetary policy, popularly known as ‘unconventional’ monetary policy, to provide further stimulus subject to the ZLB.

¹The four major central banks in this introduction refer to the Federal Reserve, European Central Bank, Bank of Japan and Bank of England.
² Central banks differed in their urgency to deploy conventional monetary policy. The Fed reduced its target interest rate by 100 basis points in the twelve months before the economy entered recession in the first quarter of 2008. The Bank of England raised interest rates in July 2007, two months before the demise of Northern Rock, and the Bank Rate was 5 per cent in October 2008 – after two quarters of economic contraction. The ECB began raising interest rates in 2011 just ahead of the full consequences of its sovereign debt crisis.