Question

Since the end of the Great Recession, interest rates have been at historic lows—in some cases, close to zero. How is expansionary monetary policy supposed to work? How do near-zero interest rates limit the ability of expansionary monetary policy to work?

Answer 1

In expansionary monetary policy, the economy is intended to be stimulated by increasing the money supply. When the money supply is increased, individuals and firms borrow more and spend/invest more. This increases economic activities and output grows.

Lowering the interest rate is one of the key tools of expansionary monetary policy. However, when the interest rate is near-zero, there is very less scope of lowering the interest rate any further and stimulate the economy. Therefore, expansionary monetary policy becomes ineffective in the case of near-zero interest rates.