The Zero Lower Bound (''ZLB'') or Zero Nominal Lower Bound (''ZNLB'') is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a

liquidity trap A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rathe ...

and limiting the central bank's capacity to stimulate economic growth. The root cause of the ''ZLB'' is the issuance of paper currency by governments, effectively guaranteeing a zero nominal interest rate and acting as an interest rate floor. Governments cannot encourage spending by lowering interest rates, because people would simply hold cash instead. Miles Kimball suggested that a modern economy either fully relying on electronic money or defining electronic money as the

unit of account In economics, unit of account is one of the money functions. A unit of account is a standard numerical monetary unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of rela ...

could eliminate the ''ZLB''. Even without such measures, however, several central banks are able to reduce interest rates below zero; for example, the Czech National Bank estimates that the lower limit on its interest rate is below -1%. The problem of the ''ZLB'' returned to prominence with Japan's experience during the 90's, and more recently with the

subprime crisis The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the 2007–2008 global financial crisis. It was triggered by a large decline in US home prices after the coll ...

. The belief that monetary policy under the ''ZLB'' was effective in promoting economy growth has been critiqued by

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was th ...

Gauti Eggertsson is an early Germanic name, from a Proto-Germanic ''gautaz'', which represents a mythical ancestor or national god in the origin myth of the Geats. Etymology ''Gautaz'' may be connected to the name of the Swedish river Göta älv at the city ...

, and Michael Woodford among others.

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...

, on the other hand, argued that a zero nominal interest rate presents no problem for monetary policy. According to Friedman, a central bank can increase the

monetary base In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is the total amount of money created by the central bank. This include ...

even if the interest rate vanishes; it only needs to continue buying bonds. Friedman also coined the term " helicopter drops" to illustrate how central banks could always generate spending and inflation. Friedman used the example of a helicopter flying over a town dropping dollar bills from the sky, which households then gathered in perfectly equal shares. Economists have argued that real-world versions of this idea would work at the zero lower bound. Typically, helicopter drops have been interpreted as involving the central bank directly financing the budget deficit. The economist

Willem Buiter Willem Hendrik Buiter CBE (born 26 September 1949) is an American-British economist. He spent most of his career as an academic, teaching at various universities. More recently, he was Chief Economist at Citigroup. Early life and education Buit ...

has argued that helicopter drops can always raise demand and inflation. Following the repeated struggles of the European Central Bank to revive the Eurozone economy and meet its inflation objective, a number of economists have taken a more literal interpretation of Friedman's parable and suggested that the European Central Bank should transfer cash directly to households.

References

External links

*Keister, Todd (November 16, 2011)
Why Is There a “Zero Lower Bound” on Interest Rates?
Federal Reserve Bank of New York. Liberty Street Economics blog. Retrieved 2 April 2020.
The zero lower bound in our minds
on Economist.com
Notes on Issues Related to the Zero Lower Bound on Nominal Interest Rates
December 12, 2008 {{2008 economic crisis Interest rates Monetary policy

See also

References

External links