Non standard monetary policy measures in the new normal
We evaluate the macroeconomic effects of long term sovereign bond purchases by the central bank in the 'New Normal' i.e. in an economy with a low equilibrium real interest rate and a high probability of hitting the zero lower bound (ZLB) on the short term policy rate. Our analysis is based on the simulations of a dynamic general equilibrium model for the euro area. The main results are the following. First, long term sovereign bond purchases reacting to a positive inflation gap help stabilize macroeconomic conditions when the monetary policy rate hits the ZLB. Second, these purchases are an effective stabilization tool following positive shocks to the sovereign term premium (financial shocks) and negative shocks to aggregate demand (real shocks) Third, purchases that also react to the long term rates are effective in the case of recessionary financial shocks but not in the case of recessionary real shocks and fourth, to stabilize the effects of expansionary shocks, the central bank can increase the short term monetary policy rate according to an 'aggressive' Taylor rule, instead of selling long term sovereign bonds.