what is a zero bound interest rate 
a central bank s weapons for stimulating the economy may become ineffective if short term interest rates are zero bound or hit zero at least that is the conventional wisdom but the assumption has been tested in the recent past and found faulty in three recent cases a central bank s action in pushing interest rates below zero seemed to have had modest success or at least not worsened the situation in all three cases the action was a response to a financial crisis understanding the zero bound interest ratein general short term interest rates are loans for less than one year bank certificates of deposit and treasury bills fall into this category for consumers and investors these are the ultimate safe haven investments they pay a minimal amount of interest but there s virtually no risk of the loss of principal the central bank such as the federal reserve in the u s revises lending rates periodically it may push lending rates lower in order to stimulate economic activity or hike them higher to slow an overheated economy it also sets the overnight lending rate that s the interest rate that banks and the fed charge each other for borrowing and loaning money amongst themselves for very short terms literally overnight but these adjustments by the federal reserve are incremental and the powers of the fed are limited so what happens when short term rates go to zero conventional wisdom says they can go no lower zero is the boundary beyond which monetary policy won t work after all below zero rates mean negative interest the borrower is asking for a loan and demanding to be paid for the privilege of taking the money or a bank is accepting your cash and demanding to be paid for the privilege until recently it was assumed that central banks in setting overnight lending rates did not have the ability to push the nominal interest rate beyond 0 and into negative territory and yet it happened in three cases yields on both the 1 month and 3 month u s treasury bills dipped below zero on march 25 2020 1march 2020 a flight to safetyin march of 2020 the u s federal reserve lowered the federal funds rate to a range of 0 0 25 in reaction to the economic slowdown caused by the start of the covid 19 pandemic 2yields on both one month and three month treasury bills dipped below zero on march 25 2020 a week and a half after the federal reserve cut its benchmark rate amid the turmoil investors flocked to the safety of fixed income investments even at a slight loss it was the first time that had happened in 4 years when a brief dip below zero had occurred 3the belief in this constraint was severely tested during the period following the financial crisis of 2007 2008 the recovery was sluggish and central banks including the u s federal reserve and the european central bank began quantitative easing programs which brought interest rates to record low levels 4the ecb introduced a negative rate policy effectively a charge for deposits on overnight lending in 2014 5japan s interest rate policy tested convention for decades for much of the 1990s the interest rate set by the japanese central bank the bank of japan hovered near the zero bound as the country struggled to recover from an economic crash and reduce the threat of deflation 6boj moved to negative interest rates in 2016 by charging depositing banks a fee to store their overnight funds japan s experience has been instructive for other developed markets 7crisis tacticsin extreme conditions it seems that central banks can pursue non conventional means of stimulating the economy a study by the new york fed found that as interest rates hovered near the zero bound it was important for the central bank to manage investor expectations that might mean assuring investors that interest rates would remain low for the foreseeable future and that the bank would continue various aggressive measures such as quantitative easing and purchases of bonds on the open markets in fact the fed s management of expectations made the sum more powerful than the component parts the study concluded 8