Negative Interest Rate Policy (NIRP)

Definition

Negative Interest Rate Policy (NIRP) is a monetary strategy implemented by a central bank to encourage economic growth by setting target interest rates below zero. Under this policy, banks are charged for holding excess reserves instead of receiving interest on them, incentivizing them to lend money rather than accumulate it. Essentially, NIRP is utilised in rare instances to prevent deflation and stimulate economic activity.

Phonetic

Negative Interest Rate Policy (NIRP) would be pronounced as follows in phonetics: “ˈnɛgətɪv ˈɪntrəst reɪt ˈpɒlɪsi (naɪərp)”

Key Takeaways

1. Negative Interest Rate Policy (NIRP) is a monetary policy tool used by central banks where nominal target interest rates are set with a negative value, below the theoretical lower bound of zero percent. This unconventional measure is typically implemented during deflationary periods when central banks have exhausted all other policy measures.
2. Encourages Spending and Investment: The main aim of NIRP is to discourage businesses and individuals from holding onto money, thereby, encouraging spending and investment. This is achieved because with negative interest rates, banks would effectively charge customers to deposit money, incentivizing them to spend or invest instead of hoarding cash.
3. Risks and Controversies: Although NIRP can stimulate economic activity in the short term, it also comes with potential downsides. These include stresses to the financial sector, particularly banks, whose profitability may be compressed by the negative rates. Additionally, it could lead to asset bubbles due to the cheap borrowing costs. There are also concerns that if rates remain negative for a prolonged period, it could encourage reckless spending and borrowing.

Importance

Negative Interest Rate Policy (NIRP) is a critical monetary policy tool for central banks. It’s important because it essentially means banks are charged for storing cash reserves, encouraging them to lend money rather than hoard it. This increases money supply in the economy, driving economic growth. Furthermore, it brings down the cost of borrowing for businesses and households, stimulating investments and spending. NIRP can also weaken a country’s currency, promoting exports by making them more price-competitive. However, it can adversely affect savers and banks’ profitability. Therefore, NIRP’s consideration represents a high-stake decision, reflecting a central bank’s effort to stimulate a stagnant economy in unconventional ways.

Explanation

The purpose of a Negative Interest Rate Policy (NIRP) is primarily to stimulate economic growth and prevent deflationary spirals during severe economic downturns. When conventional monetary policy instruments, such as lowering interest rates to zero or near-zero levels, prove insufficient to stimulate economic activity, central banks can adopt a NIRP. Under a NIRP, banks are charged for parking their excess reserves with the central bank rather than earning interest on them. This unconventional approach aims to incentivize commercial banks to increase lending to businesses and consumers, thereby enhancing economic activity. It also encourages investments into riskier assets, as safe assets provide negative returns. Furthermore, NIRP is used to weaken the domestic currency in a bid to stimulate inflation. This is done to combat deflation, which could be devastating for an economy as consumers may delay their spending in anticipation of further price declines and businesses may cut investment and hiring. Lower interest rates make holding the currency less attractive, leading to its depreciation. A weaker domestic currency can stimulate exports by making domestically produced goods cheaper to foreign buyers. At the same time, it raises the cost of imported goods, which could help raise inflation to the central bank’s target level. It’s important to note, however, that a NIRP can also have several undesired side effects, including on the profitability of banks and potentially leading to asset price bubbles.

Examples

1. Japan: The Bank of Japan introduced a negative interest rate policy in 2016. The central bank charges banks for certain deposits, aiming to encourage them to lend rather than hoard their cash. This move is also seen as an effort to reignite growth and lift inflation levels that have been frustratingly low for many years. 2. European Central Bank (ECB): The ECB, took its deposit rate (the interest rate for banks depositing money with ECB) into negative territory in 2014 as a part of a range of measures to stimulate the Eurozone economy. The idea was to discourage banks in the eurozone from holding onto cash and instead lend it out to businesses and consumers to stimulate economic growth. 3. Sweden’s Riksbank: The Swedish Riksbank was quite early in adopting a negative interest rate policy in 2009. The objective was to cope with deflation and to stimulate the economy. It intended to make it costly for banks to store money, forcing them to lend it out to stimulate the economy.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Central Bank
• Monetary Policy
• Deflation
• Inflation
• Yield Curve

Sources for More Information

• Investopedia
• Corporate Finance Institute
• International Monetary Fund
• BabyPips