Central Banks and the Zero Lower Bound: New Challenges, New Solutions

Central banks play a vital role in the global economy, using monetary policy tools to manage inflation and promote economic growth. However, when short-term interest rates reach zero, central banks face a challenge known as the zero lower bound (ZLB). At the ZLB, conventional monetary policy tools such as interest rate cuts become ineffective, limiting the central bank’s ability to stimulate the economy.

The global financial crisis of 2008 pushed many central banks into the ZLB, and they have remained there for much of the past decade. This has posed new challenges for central banks, as they have had to find new ways to stimulate the economy and maintain financial stability.

One of the main challenges facing central banks at the ZLB is the risk of deflation. Deflation is a sustained decline in the general price level, which can lead to a number of negative economic consequences, such as reduced consumer spending and investment. Central banks can mitigate the risk of deflation by pursuing policies that push inflation up to a modest target.

Another challenge facing central banks at the ZLB is the potential for financial instability. When interest rates are low, banks may be more likely to take on excessive risk, and this can increase the risk of a financial crisis. Central banks can address this challenge by using macroprudential tools to regulate the financial system and reduce risk-taking