Zero Interest Rate Policy (ZIRP) is a macroeconomic concept delineating circumstances marked by exceedingly low nominal interest rates.
This occurs when a nation’s central bank drives nominal interest rates down to 0% for its short-term benchmark.
ZIRP is considered an unconventional monetary policy tool and can be linked to sluggish economic growth, deflation, and deleveraging.
At its core, ZIRP aims to stimulate economic activity by promoting low-cost borrowing and providing greater access to affordable credit for businesses and individuals.
What is the Zero Interest Rate Policy?
Under ZIRP, the central bank maintains a 0% nominal interest rate, signifying a crucial point in monetary policy where conventional tools may no longer effectively reduce rates—the zero lower bound. This scenario poses a challenge akin to a liquidity trap, where nominal interest rates cannot adjust downward despite savings exceeding investment.
The liquidity trap arises when monetary policy becomes ineffective due to very low-interest rates, coupled with consumer preferences for saving over spending or investing in higher-yielding assets.
A liquidity trap is when monetary policy becomes ineffective due to very low interest rates combined with consumers who prefer to save rather than spend or invest in higher-yielding bonds or other investments.
ZIRP’s primary objective aligns with any period of dropping prevailing interest rates: catalyzing economic expansion, boosting inflation, discouraging cash hoarding, and encouraging lending, spending, and investment.
What is Zero Lower Bound?
The zero lower bound underscores the point where rates cannot be lowered further, limiting the central bank’s capacity to stimulate economic growth. It represents a scenario where the short-term nominal interest rate hovers around zero, creating a liquidity trap and constraining the central bank’s ability to drive economic growth. ZIRP is seen as a period when central bankers seemingly “run out of bullets” as their primary monetary policy tool becomes neutralized.
In certain instances, ZIRP transitions into a Negative Interest Rate Policy (NIRP).
Zero Interest Rate Policy in the U.S.
Looking at the United States, on December 16, 2008, amid the Global Financial Crisis, the chair of the U.S. Federal Reserve, Ben Bernanke announced the unprecedented lowering of the benchmark target interest rate to nearly zero. This marked the first instance in American history of adopting ZIRP. The Fed maintained near-zero rates for approximately seven years before gradually raising them, reaching as high as 2.5% from 2015 to 2019.
However, the progress made in returning interest rates to “normal” levels was swiftly undone. As of March 15, 2020, ZIRP officially returned to the U.S. as a defensive tactic, aiming to shield the American economy from negative shocks associated with the ongoing global coronavirus crisis.