The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment

This paper reviews alternative options for monetary policy when the short-term interest rate is at the zero lower bound and develops new empirical estimates of the effects of the maturity structure of publicly held debt on the term structure of interest rates. We use a model of risk-averse arbitrageurs to develop measures of how the maturity structure of debt held by the public might affect the pricing of level, slope and curvature term-structure risk. We find these Treasury factors historically were quite helpful for predicting both yields and excess returns over 1990-2007. The historical correlations are consistent with the claim that if the Fed were to sell off all its Treasury holdings of less than one-year maturity and use the proceeds to retire Treasury debt from the long end, on average over the 1990-2007 period this might have resulted in a 14-basis-point drop in the 10-year rate and an 11-basis-point increase in the 6-month rate. We also develop a description of how the dynamic behavior of the term structure of interest rates changed after hitting the zero lower bound in 2009. Our estimates imply that at the zero lower bound, the policy would have the same potential to lower long-term yields without raising short-term yields. ∗We thank Christiane Baumeister for assistance with obtaining some of the data for this project. †[email protected] ‡[email protected]