DEFINITION of 'Zero-Bound Interest Rate'

The lowest percentage of owed principal that a central bank can set. In monetary policy, the use of a 0% nominal interest rate means that the central bank can no longer reduce the interest rate to encourage economic growth. As the interest rate approaches the zero bound, the effectiveness of monetary policy is reduced as a macroeconomic tool. A zero-bound interest rate typically refers to the process where, by gradual steps, the interest rate approaches zero.

BREAKING DOWN 'Zero-Bound Interest Rate'

For much of the 1990s, the interest rate set by the Japanese central bank, the Bank of Japan, hovered near the zero bound. This was done in order to encourage inflation and reduce the threat of deflation, since banks typically increase interest rates to slow growth down. Zero-bound interest rate policies follow periods of major economic pullback.

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