Zero interest-rate policy (ZIRP) is a

macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy An economy is an area of the production, distributio ...

concept describing conditions with a very low nominal interest rate, such as those in contemporary Japan and in the

United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., federal district, five ma ...

from December 2008 through December 2015. ZIRP is considered to be an unconventional monetary policy instrument and can be associated with slow economic growth,

deflation In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but sudden deflati ...

and deleverage.

Overview

Under ZIRP, the

central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...

maintains a 0% nominal interest rate. The ZIRP is an important milestone in

monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often ...

because the central bank is typically no longer able to reduce nominal interest rates. ZIRP is very closely related to the problem of a

liquidity trap A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rat ...

, where nominal interest rates cannot adjust downward at a time when savings exceed investment. However, some economists—such as market monetarists—believe that unconventional monetary policy such as

quantitative easing Quantitative easing (QE) is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. Quantitative easing is a novel form of monetary p ...

can be effective at the zero lower bound. Others argue that when monetary policy is already used to the maximal extent, to governments must be willing to use

fiscal policy In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variable ...

to create jobs. The

fiscal multiplier In economics, the fiscal multiplier (not to be confused with the money multiplier) is the ratio of change in national income arising from a change in government spending. More generally, the exogenous spending multiplier is the ratio of change i ...

of government spending is expected to be larger when nominal interest rates are zero than they would be when nominal interest rates are above zero.

Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output ...

holds that the multiplier is above one, meaning government spending effectively boosts output. In his paper on this topic, Michael Woodford finds that, in a ZIRP situation, the optimal policy for government is to spend enough in stimulus to cover the entire

output gap The GDP gap or the output gap is the difference between actual GDP or actual output and potential GDP, in an attempt to identify the current economic position over the business cycle. The measure of output gap is largely used in macroeconomic ...

. Chris Modica and Warren Sulmasy find that the ZIRP policy follows from the need to refinance a high level of US public debt and from the need to recapitalize the world's banking system in the wake of the

Financial crisis of 2007–2008 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of ...

Zero lower bound

The

zero lower bound problem The Zero Lower Bound (''ZLB'') or Zero Nominal Lower Bound (''ZNLB'') is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the central bank's capacity to stimulate ...

refers to a situation in which the short-term nominal interest rate is zero, or just above zero, causing a

and limiting the capacity that the central bank has to stimulate economic growth. This problem returned to prominence with the Japan's experience during the 1990s and more recently with the subprime crisis. The belief that monetary policy under the ''ZLB'' was effective in promoting economy growth has been critiqued by economists

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was t ...

, Gauti Eggertsson and Michael Woodford among others.

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...

, on the other hand, argued that a zero nominal interest rate presents no problem for monetary policy as a central bank can increase the

monetary base In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is the total amount of money created by the central bank. This include ...

only if it continues buying bonds.

References

External links

Monetary Policy Alternatives at the Zero Bound: An Empirical AssessmentFed Funds Rate: Turning Japanese, I Really Think SoNominal Interest Rates: Less Than Zero?Macroeconomics Wiki: Zero Lower Bound Problem
{{DEFAULTSORT:Zero Interest Rate Policy Interest rates Monetary policy

Overview

Zero lower bound

See also

References

Further reading

External links