Practice question · Multiple choice
A central bank cuts rates to zero and the economy still stagnates. Why does the tool lose its grip there?
Hints
- What would you do with your money if the bank charged you to hold it?
- Ask what constrains how far below zero a nominal rate can usefully go.
Show the answer
D. Nominal rates cannot fall far below zero without cash hoarding
Why
Cash pays zero and cannot be taxed away easily, so it sets a floor beneath which rate cuts stop transmitting. That constraint is exactly why quantitative easing and forward guidance were invented after 2008, and why the debate about fiscal policy came back after decades of quiet.
Practise Monetary Policy
The app has 6 more questions on this lesson, and keeps your place in the course. Business I is free to start.
More questions on Monetary Policy
- Order the transmission of a rate cut from decision to prices.
- Sort each situation by the monetary policy it calls for.
- Match each link of the transmission chain to its description.
- Why do central banks act on _forecasts_ of inflation rather than waiting for inflation to appear?
- Which effects follow a central-bank rate _cut_, all else equal?
- Banks hold a 25% reserve ratio. Set the slider to the money multiplier.