Zero Lower Bound (ZLB)

The zero lower bound (ZLB) is the floor below which a central bank cannot easily push nominal interest rates. It exists because cash pays a nominal interest rate of zero: if banks or savers were charged much below zero on deposits, they could withdraw banknotes and store them instead. Once the policy rate is at or near that floor, the central bank can no longer stimulate the economy by cutting it further.

Because experience since 2014 showed that rates can go somewhat below zero, economists now often speak of the effective lower bound (ELB): the lowest rate a central bank judges workable before cash hoarding, damage to banks or market dysfunction outweigh the benefits. The ZLB is closely linked to the liquidity trap, zero interest-rate policy and negative interest rates.

Imagine a bank told you it would charge you to keep your savings. At some point you would take the money out and put it in a safe at home, since notes in a drawer never shrink. That simple escape route stops interest rates from falling very far below zero.

For a central bank, the problem is that cutting interest rates is its main way of encouraging spending when the economy is weak. When rates are already at zero and the economy still needs help, the usual medicine runs out, and the central bank has to reach for other, less familiar tools.

What matters for spending and investment is the real interest rate, which subtracts expected inflation from the nominal rate:

• $r$ is the real interest rate.
• $i$ is the nominal interest rate, which the ZLB stops from falling much below 0.
• $\pi^{e}$ is expected inflation.

If expected inflation is 2% and the nominal rate is 0%, the real rate is $0 - 2 = -2\%$. If an economy needs a real rate of $-4\%$ to return to full employment, the central bank cannot reach it by cutting $i$. Worse, if deflation sets in and expected inflation turns to $-1\%$, the real rate rises to $+1\%$ even with a zero policy rate, tightening conditions just when the economy is weakest. This is why a low neutral interest rate makes hitting the bound more likely.

• Japan. The Bank of Japan cut its rate to near zero in 1999 and stayed close to it for most of the following quarter century, including a period of slightly negative rates from 2016 until March 2024.
• United States. The Federal Reserve held its federal funds rate target at 0–0.25% from December 2008 to December 2015 and again from March 2020 to March 2022.
• Euro area. The ECB took its deposit rate below zero in June 2014 and as low as −0.50% in 2019, ending negative rates in July 2022.
• United Kingdom. The Bank of England cut Bank Rate to a record 0.1% in March 2020 but did not go negative.
• Switzerland and Scandinavia. The Swiss National Bank's rate reached −0.75% between 2015 and 2022, and Denmark and Sweden also used negative rates.

• Asset purchases. Quantitative easing lowers longer-term yields when short rates cannot fall.
• Forward guidance. Promising to keep rates low for longer lowers expected future short rates and so today's long rates.
• Yield targets. Yield curve control, used by the Bank of Japan from 2016 to 2024, caps a chosen bond yield.
• Negative rates. Charging on reserves can push rates a little below zero, though it squeezes banks' margins.
• Fiscal action. When monetary policy is constrained, many economists argue that fiscal policy becomes more powerful because the multiplier is larger.

Because the bound is a recurring constraint, economists have proposed ways to reduce it. Some, including former IMF chief economist Olivier Blanchard in 2010, suggested a higher inflation target, such as 4%, to leave more room for cuts. Others favour price-level or average-inflation targeting so that a period of low inflation is followed by catch-up; the Fed adopted a flexible form of average inflation targeting in 2020 and dropped it in its August 2025 review. Kenneth Rogoff and others have argued for phasing out large-denomination notes so that deeper negative rates become possible, an idea opposed on privacy and financial-inclusion grounds. A digital central bank currency could, in principle, carry a negative rate, though central banks developing one say they do not intend this.

Critics on the other side argue that long periods at the bound fuelled asset price inflation, an asset bubble risk and the survival of weak "zombie" firms, and that central banks should rely less on unconventional tools. The ZLB also shaped the ZIRP era of cheap funding for start-ups and venture capital.

• Federal Reserve: Review of Monetary Policy Strategy, Tools, and Communications