Zero-bound is a monetary policy tool where a central bank lowers short-term interest rates to zero, if needed, to stimulate the economy. When conventional interest rate strategies are exhausted, central banks often pursue unconventional methods of stimulus to revitalize economic growth.
Key Takeaways
- Zero-bound is used when a central bank lowers short-term interest rates to zero, aiming to stimulate the economy.
- Central banks adjust interest rates to either invigorate a slowing economy or temper an overheating one.
- Post-Great Recession, some central banks adopted negative interest rates as an extension of zero-bound to boost growth and spending.
Grasping the Concept of Zero-Bound
Zero-bound refers to the minimum level that interest rates can fall, typically seen as zero. The primary tool in a central bank’s monetary policy arsenal is interest rates to influence the economy’s performance. However, the limit at zero constrains further stimulus through rate cuts, making it essential to explore alternatives when this boundary is hit.
When rates reach zero but the economy remains sluggish, the scenario is described as a liquidity trap. In such cases, traditional monetary policies lose effectiveness, compelling central banks to adopt innovative measures.
One prevalent method is quantitative easing (QE), where a central bank buys large-scale assets such as treasuries and government bonds. This strategy not only keeps short-term rates low but also depresses long-term rates, encouraging borrowing and spending.
Emergence of Negative Rates
In the aftermath of the 2008-2009 Great Recession, several central banks ventured into negative interest rates. As traditional rate cuts failed to induce robust recovery, institutions like the Riksbank in Sweden, the European Central Bank (ECB), and the Bank of Japan (BOJ), among others, experimented with negative rates to foster economic activity.
For instance, in 2009, Sweden’s Riksbank reduced the repo rate to 0.25%, pushing the deposit rate to -0.25%. Such moves expanded the boundaries of monetary policy to incentivize growth through unconventional methods. This trend saw others like Switzerland maintaining negative rates to keep their currency from appreciating too rapidly, thereby preserving their export competitiveness.
Example of Zero-Bound and Negative Interest Rates in Switzerland
The Swiss National Bank (SNB) has a unique implementation of negative interest rates aimed at preventing its highly valued currency from rising further. Given the perception of Switzerland as a safe haven with low political and inflation risks, strong demand for the Swiss franc poses risks to the country’s export dynamics by strengthening the currency too much.
Negative rates in Switzerland apply to Swiss franc bank balances over a certain threshold, dissuading excessive investment flows to the franc. This policy helps manage the franc’s strength while bolstering the economy indirectly through supportive monetary conditions.
Ultimately, the SNB, like other central banks, aims to revert to positive rates but will only do so when confident that such a move will not cause undue appreciation of the currency, which could adversely affect the export sector.
In summary, as central banks navigate the complexities of zero-bound and negative rates, they deploy a blend of innovative tools to ensure stability and promote economic growth, illustrating the dynamic nature of modern monetary policy.
Related Terms: expansionary monetary policy, central bank, liquidity trap, quantitative easing, negative interest rates.
References
- Bank for International Settlements. “Ben S Bernanke: The Effects of the Great Recession on Central Bank Doctrine and Practice”, Page 3.
- The Federal Reserve System. “Quantitative Easing and the ‘New Normal’ in Monetary Policy”.
- International Monetary Fund. “How Can Interest Rates Be Negative?”
- Sveriges Riksbank. “Repo Rate Cut to 0.25 Per Cent”. Pages 1-3.
- Bloomberg. “World’s Longest-Lasting Negative Rate Regime Gets a Revamp”.
