Zero Interest-Rate Policy: What is it?

What is a Zero Interest-Rate Policy? A zero interest-rate policy, ZIRP for short, is a very simple macroeconomic concept that has been used throughout the world for over two decades and in various countries including Japan, the United Kingdom, and the United States with varying results.

ZIRP was first used by Japan in the 1990s during a decade of economic hardship that is often referred to as the Lost Decade. It was during this period of ten years that Japan implemented ZIRP, a practice in which the central bank maintains a 0 percent nominal interest rate, into its monetary policy in response to the country’s asset price bubble collapse. Investing education website Investopedia writes about Japan’s economic hardship, saying:

Consumption and investment remained optimistic through 1991, GDP growth rate was higher than 3 percent, and interest rates held steady at 6 percent. However, as stock prices plummeted in 1992, GDP growth stagnated and deflation ensued. The consumer price index, which is often used as a proxy measure for inflation rates, declined from 2 percent in 1992 to 0 percent by 1995, and period interest rates fell drastically, approaching 0 percent that same year.

The article continues, stating:

As a result of ZIRP’s inability to address stagnation and deflation, the Japanese economy fell into a liquidity trap. Despite the relative ineffectiveness of zero interest rates, Japan continues to use this policy.

While Japan’s ZIRP resulted in a negative outcome for the country, the United States implemented this strategy during its 2008 economic hardship. This period in U.S. history known as the Great Recession was caused by the housing bubble burst and shows that not all countries will end up on the wrong foot due to the effect of zero interest rates. In regards to the United States’ use of ZIRP, Investopedia writes:

In an effort to prevent an economic collapse, the Federal Reserve implemented a number of unconventional policies, including zero interest rates to reduce short- and long-term interest rates. The subsequent increase in investments is expected to have positive effects on unemployment and consumption. In 2009, the U.S. reached its lowest economic point following the financial crisis with inflation of -2.1 percent, unemployment at 10.2 percent and GDP growth plummeting to -2.8 percent. Interest rates dropped to near zero during this period. By January 2014, after roughly five years of ZIRP and quantitative easing, inflation, unemployment and GDP growth reached 1.8 percent, 6.6 percent and 3.2 percent, respectively. Although the U.S. economy continues to improve, Japan’s experience suggests long-term usage of ZIRP can be detrimental.

The U.S. currently maintains near zero interest rates.

Although the use of ZIRP has inconsistent results through history, progressive economic policy makers continue to use this interest-rate policy to stimulate their economies. What fiscal policy is effective at zero interest? According to Investopedia:

The primary benefit of low interest rates is their ability to stimulate economic activity. Despite low returns, near-zero interest rates lower the cost of borrowing, which can help spur spending on business capital, investments and household expenditures. Businesses’ increased capital spending can then create jobs and consumption opportunities.

While results of ZIRP vary, economic policies aimed at creating situations where more people spend, jobs are created, and flow of revenue within the country is generated again is what seems to encourage many countries to continue to use this uncertain strategy.

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