policymakers demonstrate

418 Charles Brendon and Giancarlo Corsetti
instrument that was considered the most important stabilization device prior
to the crisis – the nominal interest rate – no longer seems capable of injecting
additional stimulus, despite continued economic weakness. Policy innovation
is the only possible response to this, and a large part of this survey is concerned
with the theoretical and empirical literatures that are emerging to understand
(a) why the zero bound has come to matter – in a way that was not foreseen
before the crisis (outside of Japan) – and (b) what channels stabilization policy
can now exploit.
The Japanese experience is particularly noteworthy from the perspective of
part (a) of this. As we shall see, in large parts of the macroeconomic literature
it is common to treat the zero bound as a temporary concern, driven by a
short-term desire by consumers to delay purchases for some particular reason.
This perspective is very difficult to reconcile with the fact that Japan’s zero
bound episode has now lasted two decades, and shows no signs of ending soon.
The central hypothesis of the fast-growing ‘secular stagnation’ literature – that
global long-term real interest rates are now permanently lower – provides an
intriguing alternative. 11
Our survey will focus principally elsewhere, reflecting the majority of the
post-crisis academic literature to date. But we do wish to highlight here that
a central concern for ongoing research should be to ask whether Japan will
remain an outlier, or whether other OECD economies are following in its path.
10.4 The Zero Lower Bound: Implications for Stabilization Policy
This section provides a detailed analysis of the literature analysing the policy
implications of the zero bound on nominal interest rates. There is a substantial
body of work suggesting that if interest rates are constrained from falling, this
may have a causal role in worsening economic conditions. A number of different
mechanisms have been proposed in this regard. They hinge on the idea that
the zero lower bound may interfere with an adjustment process that would otherwise
ensure an efficient level of production. In particular, it may not be possible
to provide individual consumers with the incentives to spend an adequate
fraction of their current incomes. This will depress aggregate demand relative
to the production capacity of the economy, as a decline in income becomes the
only means for the economy to adjust to the low level of consumer spending.
We will examine both the alternative mechanisms that have been identified as
potential causes of depressed output, and the alternative policy options that are
available for stimulating the economy in the face of these dynamics. Where possible,
we try to frame the main contributions to the literature through the lens of
the workhorse equation at the heart of modern dynamic macroeconomics, the
consumption Euler equation. This is not intended as a particular endorsement
of the Euler condition, whose empirical relevance has often been challenged.