CandleFocus

Zero-Bound

Candlefocus Editor

Zero-bound is an economic term used to describe a central bank’s policy of pushing the target or benchmark interest rate down to zero if needed to promote economic activity. This is an extreme measure that central banks use as a last resort when other attempts at stimulating the economy have failed. In the past, central banks have only gone as low as 0.25 percent, but during the global financial crisis of 2007–08, some banks such as the Bank of England and the European Central Bank went even lower and were forced to implement zero-bound policies.

In theory, when a central bank reduces the interest rate to zero, it creates incentives for businesses to borrow and invest, which should theoretically help stimulate consumer spending. When consumer spending increases, this helps to improve the general economic health of the country. In addition, lowering interest rates is often used to protect against deflation, as it helps to lower the cost of capital for businesses, making projects more affordable and therefore more likely to be taken on.

Unfortunately, the long-term success of zero-bound policies are not always clear. It can be difficult to measure their impacts, and reducing interest rates to zero can actually have a negative effect on consumer spending in the long run, as it encourages people to save rather than spend. Furthermore, a prolonged period of zero-bound interest rates can lead to instability in the financial system and severely restrict the central bank’s ability to respond to changes in the market.

Overall, while zero-bound policies have been effective in certain instances, they are usually seen as a last resort and should not be used unless absolutely necessary. It is important that when central banks implement these policies, they are carefully monitored to ensure that the economy remains in a healthy state.

Glossary Index