The Bank for International settlement published a research paper aimed at estimating the probability of an economy hitting its effective lower bound (ELB) on the nominal interest rate and of the expected duration of such an event for eight advanced economies.
The paper estimates the probability that the economy will hit its effective lower bound for the nominal interest rate (ELB risk), ie the likelihood that the monetary authority will not be able to reduce its monetary policy rate to further ease monetary policy and must therefore consider unconventional measures.
The study focuses on eight advanced economies (Canada, the euro area, Japan, Norway, Sweden, Switzerland, the United Kingdom and the United States).The paper provides ELB risk estimates that are based on a fully estimated empirical model.
The simulation procedure based on a vector autoregression produces ELB risk estimates for both the short term, where the current phase of the business cycle plays an important role, and the medium term, where the occurrence of an ELB situation is determined mainly by the equilibrium values of macroeconomic variables. The approach in this paper makes use of data on recent actual ELB events in advanced countries.
The paper provides estimates of the ELB risk for the short and medium run. It finds that the differences in ELB risk estimates between various frameworks stem from three factors:
- whether the steady states (especially the interest rate steady state) are assumed or estimated;
- whether the uncertainty of the steady state is a part of the estimation procedure; and
- whether the model is non-linear.