Question

How can the interest rate channel still function when short term nominal interest rates are at the zero lower bound?

Short answer

When short-term nominal interest rates are at the zero lower bound, the interest rate channel continues to function.

Step-by-step solution

Step 1. Concept of nominal interest 

Interest rate channels can still function at zero lower limit short-term nominal interest rates if the central bank commits to future accelerated monetary policy.

Step 2. Explanation

When the central bank commits to future accelerating monetary policy, interest rate channels can still function at zero lower bound short-term nominal interest rates. Even if nominal interest rates are at zero, this future accelerating monetary policy will boost projected inflation, and therefore interest rates will fall.

As a result, by lowering real interest rates, the interest rate channel can still operate at zero lower limit nominal interest rates.