Zero interest rate policy

Zero interest-rate policy (ZIRP) is a macroeconomic concept describing conditions with a very low nominal interest rate, such as those in contemporary Japan and December 2008 through December 2015 in the United States. ZIRP is considered to be an instrument of the unconventional monetary policy and can be associated with slow economic growth, deflation, and deleverage.

Under ZIRP, the central bank maintains a 0% nominal interest rate. The ZIRP is an important milestone in monetary policy because the central bank is no longer able to reduce nominal interest rates—it is at the zero lower bound. Conventional monetary policy is at its maximum potential to drive growth under ZIRP. ZIRP is very closely related to the problem of a liquidity trap, 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 can be effective at the zero lower bound.

Others argue that when monetary policy is already used to maximum effect, to create further jobs, governments must use fiscal policy. The fiscal multiplier 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 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.

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