Zero interest-rate policy
The 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, since December 16, 2008, in the United States. It can be associated with slow economic growth.
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. Monetary policy is at its maximum potential to drive growth under ZIRP, because the central bank has no more tools left to stimulate borrowing. ZIRP is very closely related to the problem of a liquidity trap, where nominal interest rates cannot adjust downward at a time when the loanable funds market has not cleared.
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.[1]
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.[2]
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[edit] See also
- History of Federal Open Market Committee actions
- Excess reserves
- Federal funds rate
- Liquidity trap
- Negative interest rate
- Quantitative easing
- Real interest rate
- Stagflation
[edit] References
- ^ Woodford, Michael. "Simple Analytics of the Government Expenditure Multiplier," NBER Working Paper 15714 http://www.nber.org/papers/w15714.
- ^ Chris Modica, Warren Sulmasy. "Why the Federal Reserve Bank Has a Near Zero Interest Rate Policy," YAHOO! Finance http://finance.yahoo.com/news/why-federal-bank-near-zero-143000544.html
[edit] Further reading
- Eggertsson, Gauti B.; Woodford, Michael (2003). "The Zero Bound on Interest Rates and Optimal Monetary Policy". Brookings Papers on Economic Activity 2003 (1): 139–211. doi:10.1353/eca.2003.0010. JSTOR 1209148.
[edit] External links
- Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment
- Fed Funds Rate: Turning Japanese, I Really Think So
- Nominal Interest Rates: Less Than Zero?
- Bank-of-Japan gives away money interest-free
- Rising Islamic bankers face surprise challenge from Fed
- Hopes for the Future of Islamic Finance
