Real Balance Effects When the Nominal Interest Rate is Zero

What are the economic effects of a large increase in real balances of money on the economy when the nominal interest is zero? This paper considers this question using a computable overlapping generations model. In this model increases in money supply that increase the overall stock of government debt have real effects. Results from a dynamic simulation analysis indicate that monetary policies such as quantitative easing that temporarily increase real balances of money act to raise the real interest rate, crowd out private capital formation, depress economic activity and increase deflationary pressure. ∗Corresponding author: Faculty of Economics, University of Tokyo, e-mail: [email protected]. The views expressed in the paper are those of the authors and not those of the Bank of Japan. We are grateful for comments received from seminar participants at the Bank of Japan, Universitat Pompeu Fabra, the Institute for Advanced Studies in Vienna, the Universitat Autonoma Barcelona, the European University Institute, Centro Estudios Monetarios y Financieros, the Deutsche Bundesbank, the University of Virginia, the Federal Reserve Bank of Richmond, and the Federal Reserve Bank of Chicago.