The Federal Reserve Bank of New York’s Liberty Street Economics has released a new analysis on the zero lower bound (ZLB) risk, which indicates that despite higher interest rates, the perceived risk of returning to the ZLB remains significant over the medium to long term.
Researchers analyzed financial market prices to estimate perceived probability distributions for future short-term interest rates and found that the expected level of interest rates has changed over time, tracking movements in the federal funds rate. The analysis also showed that uncertainty has fluctuated, typically rising during periods of economic stress or major shifts in monetary policy.
The study used data from January 2, 2007, to May 27, 2025, and found that the expected level of interest rates is a key driver of variation in ZLB risk over time. The relationship between expected interest rates and ZLB risk is strongly negative and nonlinear, with ZLB risk rising sharply as the expected level approaches zero.
The analysis also revealed that the term structure of ZLB risk refers to the probability of being constrained by the ZLB at the end of each forecast horizon. The recent term structures reflect a broadly representative pattern, where ZLB risk tends to be upward-sloping for longer horizons.
Key findings include:
– ZLB risk remains significant over the medium to long term, similar to levels observed in 2018.
– Elevated uncertainty offsets higher expected interest rates, resulting in comparable likelihood of reaching the ZLB.
– The expected level of interest rates is a key driver of variation in ZLB risk over time.
– The relationship between expected interest rates and ZLB risk is strongly negative and nonlinear.
Source: https://libertystreeteconomics.newyorkfed.org/2025/07/the-zero-lower-bound-remains-a-medium-term-risk