ZIRP (zero interest rate policy) – The two edged sword

From Bloomberg:

“The U.S. Federal Reserve will probably cut interest rates to zero percent over the next two months to staunch deflation, according to JPMorgan Chase & Co.”

Some economists are already feeling that additional policy easing could be appropriate ... given recent data and developments in financial markets, 'some' may have turned into ‘most’,

While this may prove to be correct, it certainly isn't an obvious move. First, most central banks regard getting below 1% short term rates is dangerous territory. ZIRP let to a deflationary trap for Japan, and there isn't a particularly good reason to think it will fare better here.

Taking the target rate to zero percent would not be costless for the Fed. Public confidence may drop and led to the perception that the Fed has run out of options. Some saw a risk that the inflation rate will fall below the Fed's objective of price stability.

In addition, once short term rates fall below 1%, money market funds have trouble operating profitably. The Fed may find itself not merely acting as a big player in the commercial paper market (money market funds are big buyers of CP), but becoming the ONLY player. That would not be good.