What Is Zero-Bound?
Let me explain zero-bound to you directly: it's an expansionary monetary policy tool where a central bank drops short-term interest rates to zero if necessary to kickstart the economy. If that's not enough, the bank has to turn to other, often unconventional, methods to get things moving again.
Key Takeaways
- Zero-bound is an expansionary monetary policy tool where a central bank lowers short-term interest rates to zero, if needed, to stimulate the economy.
- Central banks will manipulate interest rates to either stimulate a stagnating economy or dampen an overheating one.
- The Great Recession forced some international central banks to push the limits of zero-bound below the numerical level and implement negative rates to spur growth and spending.
Understanding Zero-Bound
You need to know that zero-bound is the lowest point interest rates can reach, and logically, that's zero. As a central bank, the primary tool in your monetary policy arsenal is adjusting interest rates—raise them to cool an overheating economy or lower them to revive a sluggish one. But there are clear limits, especially on the downside.
The zero-bound marks the floor for rate cuts; you can't go below it without issues. If the economy is still lagging at this point, interest rate stimulus is off the table. Economists call this a liquidity trap.
In a liquidity trap, you have to look for alternative ways to stimulate the economy. The old thinking was that rates couldn't go negative—once you're at zero or something like 0.01%, you shift gears to keep stabilizing or boosting growth.
The go-to alternative is quantitative easing (QE), where the central bank buys up large amounts of assets, like treasuries and government bonds. This keeps short-term rates low and drives down longer-term rates, making borrowing more attractive.
Negative Rates
Since the Great Recession of 2008 and 2009, some central banks have broken through the zero-bound by introducing negative rates. With the global economy in freefall, they slashed rates to encourage growth and spending, but when recovery dragged, they ventured into negative territory.
Sweden led the way in 2009, when the Riksbank set its repo rate to 0.25%, dropping the deposit rate to -0.25%. After that, the European Central Bank (ECB), the Bank of Japan (BOJ), and others have done the same at various points.
Negative rates aren't just for crises; they've been used in normal times too. Switzerland kept its target rate at -0.75% through much of the 2010s, bumping it to -0.50% in 2021. Japan has a negative interest rate policy (NIRP) targeting -0.1%.
Example of Zero-Bound and Negative Interest Rates in Switzerland
Take the Swiss National Bank (SNB)—it runs a negative interest-rate policy. While other countries have used negative rates, Switzerland's case stands out because it's not about stimulating a weak economy; it's to stop the currency from getting too strong.
Important point: in Switzerland, negative rates apply only to Swiss franc bank balances above a certain threshold.
Switzerland is seen as a safe haven with low political and inflation risks. Usually, negative or zero-bound policies respond to economic crises needing rate cuts for stimulus, but that's not Switzerland's story.
The SNB insists on low rates to keep the already high Swiss franc from climbing further, as that would damage exports. So, they use a dual strategy: intervening in currency markets to cap the franc's value and maintaining low or negative rates to deter speculative buying.
Eventually, the SNB will shift to a zero-bound approach, moving rates back to 0% or higher. But they'll only do that when they believe it won't spike the currency too much.
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