Introduction

The current global financial and economic crisis is perhaps unique in the number of countries that have seen short-term interest rates fall to nearly zero. Countries with policy rate targets of 0.5% or less include United States, Japan, United Kingdom, and Canada. Although Japan is the only Asian country with official rates this low, short-term money market rates have sunk to nearly zero in a number of economies, including Hong Kong, China; Japan; Singapore; and Taipei,China (see Figure 1 [ PDF 16KB | 1 page ]). Because conventional monetary policy operates mainly by setting interest rate levels, this means that the limits of conventional policy have already been reached in these economies, and that any further monetary stimulus must be obtained from “unconventional” means.

The current crisis has also been characterized by a breakdown in the normal transmission mechanism of monetary policy. Reflecting a sharp increase in perceived risk of insolvency of financial institutions and other firms, spreads widened sharply in a number of markets, including those for interbank deposits, commercial paper, corporate bonds, and government bonds in emerging economies. Some markets stopped functioning altogether, especially those related to asset-backed securities. As a result, a reduction of policy rates often failed to be reflected in a commensurate decline in market rates, while, in some cases, a credit crunch developed where credit was not forthcoming at all. This situation can occur even when short-term rates are above zero, but still calls for unconventional policy responses.

Section 2 of this paper reviews the range of “unconventional” monetary policy tools available to central bankers and summarizes their theoretical strengths and weaknesses. Section 3 reviews available empirical studies of their effectiveness and other recent evidence. Section 4 reviews issues related to exit strategies and other risks. Section 5 assesses the applicability of unconventional monetary policy measures to the current situation of Asian economies and other emerging markets.

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