Which two unconventional monetary policy tools are commonly used when policy rates are near zero, and what is their intended effect?

• A. Quantitative easing (asset purchases) and forward guidance; intended to lower long-term rates and stimulate demand when short rates cannot be lowered further.
• B. Open market operations and reserve requirements; intended to tighten monetary conditions
• C. Currency pegs and capital controls; intended to stabilize exchange rates
• D. Discount window loans and moral suasion; intended to provide liquidity short-term

Answer: (A)

When policy rates hit the zero lower bound, central banks turn to unconventional tools that push on the economy in different ways than normal rate cuts. Quantitative easing, or asset purchases, works by buying long‑term securities. This raises their prices and lowers long-term interest rates, making borrowing cheaper for households and businesses and encouraging investment and spending. Forward guidance complements this by shaping expectations about future policy paths—if the central bank signals that rates will stay low for longer, lenders and borrowers adjust their behavior today, which helps stimulate demand even without cutting short-term rates further.

The other options don’t fit the usual near-zero tools. Open market operations and reserve requirements are traditional tools and don’t constitute the main unconventional approach used when rates are already at or near zero. They aren’t inherently aimed at lowering long-term rates or boosting demand in the same way. Currency pegs and capital controls focus on exchange-rate stability rather than domestic demand stimulation through lower borrowing costs. Discount window lending and moral suasion provide liquidity or influence behavior, but they don’t target long-term rates or aggregate demand as effectively as asset purchases plus forward guidance.