Worries about the zero bound from 2002 to 2005 led the Fed to

Question

Quizplus · Accepted Answer

Worries about the zero bound refer to the fact that if the nominal interest rate on safe assets, such as treasury bonds and deposits at the central bank, is close to zero, there is no room for the central bank to lower the rate further in order to stimulate the economy in case of a recession. This is because people would simply hold cash, which pays zero interest, rather than bonds or bank deposits. Therefore, in order to avoid this situation, the Fed kept the Federal funds rate (the rate at which banks lend to each other overnight) below the inflation rate during this period, so that the real interest rate would remain negative and encourage borrowing and spending. This policy is known as maintaining an accommodative stance or stance of monetary easing. The other options (A,B,C) would have had the opposite effect of tightening monetary conditions and making it harder for the economy to recover from a recession.

Worries About the Zero Bound from 2002 to 2005 Led