How Big a Problem is the Zero Lower Bound on Interest Rates?
How big a problem is the zero lower bound on interest rates?: If inflation is too low or unemployment too high, the Fed normally responds by pushing down short-term interest rates to boost spending. However, the scope for rate cuts is limited by the fact that interest rates cannot fall (much) below zero, as people always have the option of holding cash, which pays zero interest, rather than negative-yielding assets. When short-term interest rates reach zero, further monetary easing becomes difficult and may require unconventional monetary policy, such as large-scale asset purchases (quantitative easing).
Before 2008, most economists viewed this zero lower bound (ZLB) on short-term interest rates as unlikely to be relevant very often and thus not a serious constraint on monetary policy. (Japan had been dealing with the ZLB for several decades but was seen as a special case.) However, in 2008 the Fed responded to the worsening economic crisis by cutting its policy rate nearly to zero, where it remained until late 2015. Although the Fed was able to further ease monetary policy after 2008 through unconventional methods, the ZLB constraint greatly complicated the Fed’s task.
How big a problem is the ZLB likely to be in the future? ...
Posted by Mark Thoma on Wednesday, April 12, 2017 at 07:48 AM in Economics, Monetary Policy |
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