Joint post with Frances Coppola
There are some things which are obvious to many people. There are others which need constant reminder, even though they are perhaps more significant than the more obvious. In both cases though, remembering is important: it allows us to understand how things work, and when they do not work it allows us to understand how to fix them. Yet, the caveat here is that nothing works all the time; there is no panacea and we have to re-examine whether our understanding fits what we are trying to resolve. Here are some of the facts we should remember.
1. The Zero Lower Bound (ZLB) does not mean rates are necessarily zero
As Frances Coppola stated, the point of the ZLB is not that the interest rate is very close to zero. It’s the fact that actual interest rates for some reason cannot fall further even though the equilibrium rate of interest is lower. This renders monetary policy ineffective. In the ZLB theory, the assumption is that the existence of physical cash means that interest rates cannot fall much below zero, since people will start to hoard physical cash to avoid the negative rates. But in the Eurozone, the same effect occurs even though real rates are much higher.
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