The Potential Instruments of Monetary Policy

Although nominal interest rates are constrained by the zero lower bound (ZLB), Central Banks can increase the monetary base (M0), e.g. by Quantitative Easing (QE). But the link, money multiplier, between M0 and the wider monetary aggregates has collapsed. Although QE was, nevertheless, originally successful, it is now largely a spent force. It could be given some additional power by complementing it with reductions in interest payments on (marginal) excess reserves (IOER). But neither will have any significant effect in raising bank lending to the private sector. In order to kick start that, one should aim to lower bank marginal funding costs. The Funding for Lending Scheme (FLS) is a good start. If that should not be enough, then have the Central Bank buy bank bonds, and, if yet more is required, try forcible dilution, whereby the authorities injects more equity into those banks which are failing to expand.