Thezero lower bound (ZLB) orzero nominal lower bound (ZNLB) is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing aliquidity trap and limiting the central bank's capacity forinflation targeting.
The root cause of the ZLB is the issuance of paper currency by central banks, effectively guaranteeing a zero nominal interest rate and acting as an interest rate floor. Central banks cannot encourage spending by lowering interest rates, because people would simply hold cash instead. However, several central banks were 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%.[1]
The problem of the ZLB returned to prominence withJapan's experience during the 1990s, and more recently with thesubprime crisis. The belief that monetary policy under the ZLB was effective in promoting economy growth has been critiqued byPaul Krugman,Gauti Eggertsson, andMichael Woodford among others.
Milton Friedman, 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 themonetary base even if the interest rate vanishes; it only needs to continue buying bonds.[2] 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.[3]
The economistWillem Buiter has argued thathelicopter money can always raise demand and inflation.[4] 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.[5][6][7]
Miles Kimball suggested that a modern economy either fully relying ondigital currency or defining electronic money as theunit of account could eliminate the ZLB.[8]
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