Zero lower bound

A constraint on conventional monetary policy rather than a rule anybody wrote. Cutting the policy rate is the ordinary way a central bank loosens conditions, and the cut works because it is passed through the banking system into what savers earn and borrowers pay. Once the rate is at or below zero, that pass-through weakens, because a saver charged for holding a deposit has an alternative that pays nothing at all: banknotes. Cash is the floor the argument rests on, and it is the reason the bound exists at zero rather than anywhere else.

The bound turned out to be soft. Holding banknotes in size is not free, since they have to be stored, insured, counted and moved, so the rate can go somewhat below zero before cash becomes the better option, and several authorities took it there, among them the European Central Bank, the Swiss National Bank, the Bank of Japan, the Riksbank and Danmarks Nationalbank. Economists now generally write about an effective lower bound, meaning the level at which further cuts stop transmitting, which is a place that has to be estimated rather than a number that can be looked up.

What follows from the bound is the part that reaches a price screen. A committee that cannot cut further reaches for balance sheet tools instead, principally quantitative easing and explicit guidance about how long conditions will be held. So the thing a currency or a bond market reprices against changes: with the policy rate pinned, expectations attach to the size of the balance sheet and to the wording of the guidance, and a meeting that leaves the rate untouched can still move markets sharply. A related consequence is that the market's implied path becomes asymmetric, since a rate at the floor has more room above it than below.

Two things are commonly misread. The bound is a limit on one instrument, not on policy as a whole, so the widespread phrase about a central bank being out of ammunition describes the rate rather than the toolkit. And whether the excursion below zero achieved what was intended is genuinely disputed: supporters point to easier conditions and weaker exchange rates, critics point to compressed bank margins, and a strand of the literature argues that beyond some reversal rate a further cut tightens conditions rather than loosening them by squeezing the lenders who are supposed to pass it on. That argument is unresolved, and the estimates of where such a rate would sit differ widely.