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Since the credit crunch and global downturn in 2008, governments everywhere have responded to the shortfall in aggregate demand in a standard textbook Keynesian fashion. To degrees, they have adopted fiscal stimuli: ramping up government expenditures and cutting taxes. Central banks followed the lead of the U.S. Federal Reserve by driving short-term interest rates toward zero; almost exactly zero for overnight interbank rates in the U.S., Japan, and Canada, and generally less than 1 percent in Europe into the fall of 2009.

In a statement on September 23, 2009, the Fed repeated that it would keep its benchmark overnight interest rate at virtually zero for an “extended period.” But are these near-zero interest rates the appropriate policy response?