Editors' Summary

The brookings panel on Economic Activity held its seventy-eighth conference in Washington, D.C., on September 9 and 10, 2004. This issue of Brookings Papers on Economic Activity includes the papers and discussions presented at the conference. The first paper evaluates unconventional measures available to monetary policymakers for stimulating the economy when interest rates are already near zero, a situation that may arise with price stability or negative inflation. The second paper presents empirical evidence on the effects of taxes, federal spending, and deficits on national saving, interest rates, and growth. The third paper explores the impacts on U.S. employment in recent years from conventional foreign trade in goods and from the rise in offshoring of service jobs. The fourth paper examines the effect of tax changes, such as those passed since 2000, on business capital formation.

Central Banks Usually implement monetary policy by setting the short-term nominal interest rate that the bank controls, such as the federal funds rate in the United States. However, the success of many industrial countries over the years in reducing inflation and, consequently, average nominal interest rates has increased the likelihood that, during a recession, the policy rate will approach its lower bound of zero. When rates are at or near zero, a central bank can no longer stimulate aggregate demand by further rate reductions and must rely instead on "nonstandard" policy alternatives. An extensive literature examines these alternatives, but for the most part from a theoretical or historical perspective. Few studies have presented empirical evidence on their potential effectiveness in modern economies. Such evidence not only would help central banks plan for the contingency of the policy rate approaching zero, but also would bear directly on the choice of the appropriate inflation objective in normal times: the greater the confidence of central bankers that tools exist to help the economy escape the liquidity trap that occurs at the zero bound, the less need there is to maintain an inflation "buffer." Hence evidence of effective alternative policies would bolster the argument for a lower inflation objective. In the first article of this issue, Ben Bernanke, Vincent Reinhart, and Brian Sack apply the tools of modern empirical finance to the recent experiences of the United States and Japan to look for such evidence.¹

Following earlier work by Bernanke and Reinhart, the authors group nonstandard policy alternatives into three classes: official communications designed to shape public expectations about the future course of interest rates; quantitative easing, which increases both assets (holdings of government securities) and liabilities (unborrowed reserves) on the central bank's balance sheet; and changes in the composition of that balance sheet through, for example, targeted purchases of long-term bonds aimed at reducing long-term interest rates.

The authors' investigation employs two approaches. First, they perform event-study analysis, measuring and analyzing the behavior of selected asset prices and yields over short periods surrounding central bank statements or other financial or economic news. Second, they estimate "no-arbitrage" models of the term structure of interest rates for both the United States and Japan. For any given set of macroeconomic conditions and stance of monetary policy, these models allow the authors to predict interest rates at all maturities. Using the predicted term structure as a benchmark, they are then able to assess whether factors not included in the model—such as the Bank of Japan's quantitative easing policy that began in 2001—have economically significant effects on interest rates.

Bernanke, Reinhart, and Sack begin with a discussion of nonstandard policies that might be effective in stimulating the economy when short-term rates are at the zero bound; the discussion draws on the historical experience with such policies in the United States and Japan as well as on existing theories of potential policy channels and previous empirical analysis. The first type of policy they consider is the use of central bank communications to influence the market's expectations about future policy and hence future short-term rates. According to some theories, shaping expectations about future short-term rates is essentially the only tool central bankers have. But the authors take a broader view, arguing that...