MONETARY POLICY AND
THE ZERO BOUND: In response to economic weakness, the Federal Reserve lowered its target for the overnight federal funds rate from 6 ˝ percent to 1 percent over a two and one-half year period. Recently, there has been much commentary expressing concern that additional steps to ease policy could cause the target to hit a lower limit of zero percent, creating what is known as the “zero bound problem.” Gordon H. Sellon, Jr., economist and vice president at the Federal Reserve Bank of Kansas City, examines how monetary policy can be conducted when short-term interest rates reach the zero bound and whether policy is likely to be effective in this situation in the article “Monetary Policy and the Zero Bound: Policy Options When Short-Term Rates Reach Zero.” The article is featured in the fourth quarter 2003 edition of the Economic Review. Sellon concludes that zero bound should not be viewed as an insurmountable problem. Even when short-term rates are near zero, central banks will generally have considerably scope to expand bank credit and lower long-term rates. Additionally, Sellon writes that there are further options available for providing stimulus in the event the banking system does not function effectively or long-term rates also reach zero. Sellon notes, however, that all of the policy alternatives come with associated costs and difficulties and, to be effective, require a central bank to communicate effectively with financial markets and the public. The article and past editions of the Economic Review are available on the Bank’s Web site at www.kansascityfed.org. # # # Return to www.kansascityfed.org
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