The Zero Lower Bound
What Is The Zero Lower Bound?
The zero lower bound refers to the situation in which a central bank has cut its policy interest rate to near zero and cannot easily push it much lower, because sharply negative interest rates create their own problems. When the federal funds rate is pinned near zero, the Fed's conventional main tool - cutting rates to stimulate the economy - is largely exhausted. The United States has reached this point twice in recent history: the FOMC lowered its target to a range of 0%-0.25% in December 2008 during the financial crisis, and it again cut to near zero in an emergency move in March 2020 as the pandemic struck.
Why It Matters
The zero lower bound matters because it fundamentally constrains monetary policy just when the economy may need the most help. Once conventional rate cuts are used up, the Fed turns to unconventional tools: quantitative easing, in which it buys large quantities of bonds to push down longer-term rates, and forward guidance, in which it shapes expectations about how long rates will stay low. Both the 2008 and 2020 episodes followed exactly this pattern. The constraint is also a central reason the Fed targets 2% inflation rather than 0%: a modest positive inflation rate keeps normal interest rates a bit higher, leaving more room to cut before hitting the bound.