Have We Underestimated the Likelihood and Severity of Zero Lower Bound Events?


  • We thank Peter Chen and Justin Weidner for excellent research assistance. In addition, we thank Jim Clouse, Bill English, Joe Gagnon, David Lopez-Salido, Ed Nelson, Athanasios Orphanides, Chris Sims, Lars Svensson, Andrea Tambalotti, David Wilcox, two anonymous referees, and participants at the Federal Reserve Bank of Boston's 55th Economic Conference on “Revisiting Monetary Policy in a Low Inflation Environment” and other conferences for helpful suggestions. The opinions expressed are those of the authors and do not necessarily reflect views of the Federal Reserve Bank of San Francisco, the Board of Governors of the Federal Reserve System, or anyone else in the Federal Reserve System.


Prior to the financial crisis, most economists probably did not view the zero lower bound (ZLB) as a major problem for central banks. Using a range of structural and statistical models, we find that previous research understated the ZLB threat by ignoring uncertainty about model parameters and latent variables, focusing too much on the Great Moderation experience, and relying on structural models whose dynamics cannot generate sustained ZLB episodes. Our analysis also suggests that the Federal Reserve's asset purchases, while materially improving macroeconomic conditions, did not prevent the ZLB constraint from having first-order adverse effects on real activity and inflation.