Deflation and the Zero Lower Bound on Nominal Interest Rates

The threat of deflation combined with the zero lower bound on interest rates has recently been intensely debated in economics. The consequences of a deflationary recession are manifold and severe as the Japanese example demonstrates. In this paper, we focus on the potential connections between (the risk of) deflation and financial markets. More specifically, we discuss the main implications for monetary policy in a deflationary environment. We also discuss direct and indirect effects of deflation on the functioning of financial markets. The experience of Japan is used as a benchmark case for the theoretical discussion.