Federal Reserve Bank of San Francisco Working Paper Series Using a Long-term Interest Rate as the Monetary Policy Instrument Using a Long-term Interest Rate as the Monetary Policy Instrument *

The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System.. Abstract: Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy—that is, multiple rational expectations equilibria—may often result. However, a policy rule with a long rate policy instrument that responds in a " forward-looking " fashion to inflation expectations can avoid the problem of indeterminacy. * The views expressed herein are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of San Francisco. [Fed Chairman] Greenspan assured the congressional Joint Economic Committee that even with the Fed's key economic policy lever, the federal funds rate, at a 41-year low of 1.25 percent, the central bank has other resources to influence interest rates to jump-start economic growth. He said that in addition to pushing the funds rate, the interest that banks charge each other on overnight loans, closer to zero, the Fed can simply begin buying longer-term Treasury securities to drive longer-term interest rates lower.