This note uses a nonlinear structural vector autoregression model to empirically investigate the effectiveness of official foreign exchange (FX) interventions in an economy when interest rates are constrained to the zero level, based on Japanese data in the 1990s. The model allows us to estimate the effects of FX interventions operating through different channels. We find that FX interventions are still capable of influencing the foreign exchange rate in a zero-interest-rate environment, even though their effects are greatly reduced by the zero lower bound on interest rates. Our results suggest that although it might be feasible to use the exchange rate as an alternative monetary policy instrument at zero interest rates as proposed by McCallum (Inflation Targeting and the Liquidity Trap, NBER working paper 8225, 2000), the exchange rate–based Taylor rule may not be very effective in achieving the ultimate policy goals.
