Zero Lower Bound - Definition & Explanation - PrudentWater
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Zero Lower Bound

Zero lower bound describes a problematic economic situation in which the key interest rate of a country (Federal Funds Rate for the USA) is close to or at zero, but the central bank would actually like to lower interest rates further in order to continue to support and stimulate the economy. The central bank thus finds itself in a kind of ‘monetary policy trap’. It would like to lower the key interest rate further in order to generate economic growth and increase the inflation rate, but it cannot theoretically do so any further because the key interest rate is already close to the zero bound. Zero lower bound has already been disproved in practice, however. The respective central banks of Switzerland, Sweden and Denmark introduced negative policy rates in 2014 and 2015, thereby circumventing the zero lower bound problem and further supporting their respective economy. Moreover, the central bank can achieve its goals through other monetary policy tools such as quantitative easing. Furthermore, if the central bank of a country is confronted with the zero lower bound problem today, public demands for fiscal policy measures are instead increasingly arising. This is because in a zero lower bound situation fiscal policy measures are then seen as a more sustainable tool to support the economy and the labour market as well. In any case, however, the zero lower bound problem can be avoided by moving the country’s key interest rate into negative territory.