This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

  1. Home
  2. Journals
  3. American Economic Review
  4. August 2021
  5. What to Expect from the Lower Bound on Interest Rates: Evidence from Derivatives Prices

What to Expect from the Lower Bound on Interest Rates: Evidence from Derivatives Prices

  • Thomas M. Mertens
  • John C. Williams
American Economic Review
vol. 111, no. 8, August 2021
(pp. 2473-2505)
Download Full Text PDF

Abstract

This paper analyzes the effects of the lower bound for interest rates on the distributions of inflation and interest rates. In a New Keynesian model with a lower bound, two equilibria emerge: policy is mostly unconstrained in the "target equilibrium," whereas policy is mostly constrained in the "liquidity trap equilibrium." Using options data on interest rates and inflation, we find forecast densities consistent with the target equilibrium and find no evidence in favor of the liquidity trap equilibrium. The lower bound has a sizable effect on the distribution of interest rates, but its impact on inflation is relatively modest.

Citation

Mertens, Thomas M., and John C. Williams. 2021. "What to Expect from the Lower Bound on Interest Rates: Evidence from Derivatives Prices." American Economic Review, 111 (8): 2473-2505. DOI: 10.1257/aer.20181461

Additional Materials

JEL Classification

  • E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian
  • E23 Macroeconomics: Production
  • E31 Price Level; Inflation; Deflation
  • E43 Interest Rates: Determination, Term Structure, and Effects
  • E52 Monetary Policy
  • G13 Contingent Pricing; Futures Pricing; option pricing