Zero Lower Bound
The constraint that limits central banks from cutting nominal interest rates below zero.
What is Zero Lower Bound?
The zero lower bound (ZLB) refers to the effective floor on nominal interest rates — in theory, zero, since people could hold physical cash at a 0% return rather than accept a negative rate at a bank. When the economy needs stimulus but rates are already at or near zero, central banks cannot use their conventional tool of rate cuts. This creates a significant constraint on monetary policy during deep recessions. Economists have proposed and implemented alternatives including quantitative easing, forward guidance, negative interest rates (which some European and Japanese central banks have tried), and yield curve control. The ZLB has been a central challenge for monetary policy since the 2008 financial crisis.
Example
The Federal Reserve cut the federal funds rate to 0–0.25% in December 2008 in response to the financial crisis and maintained it there until December 2015. Unable to cut further, it turned to quantitative easing, purchasing $3.5 trillion in bonds to lower long-term interest rates as a substitute for conventional rate cuts.