Negative Interest Rate Policy (NIRP)

What Is a Negative Interest Rate Policy (NIRP)?

A negative interest rate policy (NIRP) is an unconventional monetary policy device employed by a central bank by which nominal target interest rates are set with a negative value, below the hypothetical lower bound of zero percent. A NIRP is a somewhat new development (since the 1990s) in monetary policy used to relieve a financial crisis, and has just been formally established under extraordinary economic conditions.

Making sense of Negative Interest Rate Policies

A negative interest rate means that the central bank (and maybe private banks) will charge negative interest. Rather than getting money on deposits, depositors must pay routinely to keep their money with the bank. This is intended to boost banks to loan money all the more unreservedly and organizations and people to invest, loan, and spend money as opposed to pay a fee to keep it safe. This occurs during a negative interest rate environment.

During deflationary periods, individuals and organizations crowd money as opposed to spending and investing. The outcome is a collapse in aggregate demand, which prompts prices falling even further, a slowdown or halt in real production and output, and an increase in unemployment. A loose or expansionary monetary policy is normally employed to deal with such economic stagnation. In any case, assuming deflationary powers are adequately strong, basically cutting the central bank's interest rate to zero may not be adequate to animate borrowing and lending.

The Theory Behind Negative Interest Rate Policy (NIRP)

Negative interest rates can be considered a final desperate attempt to support economic growth. Essentially, it's put into place when all else (each and every type of traditional policy) has proved incapable and may have failed.

Hypothetically, targeting interest rates below zero will reduce the costs to borrow for companies and households, driving demand for loans and boosting investment and consumer spending. Retail banks might decide to incorporate the costs associated with negative interest rates by paying them, which will negatively impact profits, instead of passing the costs to small depositors for fear that, if not, they should move their deposits into cash.

Real World Examples of NIRP

An illustration of a negative interest rate policy is set the key rate at - 0.2 percent, with the end goal that bank depositors would need to pay two-tenths of a percent on their deposits rather than getting any kind of positive interest.

• The Swiss government ran a de facto negative interest rate system in the mid 1970s to counter its currency appreciation due to investors escaping inflation in different parts of the world.
• In 2009 and 2010, Sweden and, in 2012, Denmark utilized negative interest rates to stem hot money flows into their economies.
• In 2014, the European Central Bank (ECB) organized a negative interest rate that simply applied to bank deposits intended to prevent the Eurozone from falling into a deflationary spiral.

However fears that bank customers and banks would move all their money holdings into cash (or M1) didn't emerge, there is an evidence to propose that negative interest rates in Europe cut down interbank loans.

There are a few risks and potential unintended results associated with a negative interest rate policy. Assuming banks punish households for saving, that could not be guaranteed to urge retail consumers to spend more cash. All things being equal, they might accumulate cash at home. Organizing a negative interest rate environment might in fact move a cash run, triggering households to pull their cash out of the bank to abstain from paying negative interest rates for saving.

Banks that wish to stay away from cash runs can forgo applying the negative interest rate to the relatively small deposits of household savers. All things considered, they apply negative interest rates to the large balances held by pension funds, investment firms and other corporate clients. This urges corporate savers to invest in bonds and different vehicles that offer better returns while protecting the bank and the economy from the negative effects of a cash run.

Features

• This extraordinary monetary policy instrument is utilized to strongly empower borrowing, spending, and investment as opposed to hoarding cash, which will lose value to negative deposit rates.
• A negative interest rate policy (NIRP) happens when a central bank sets its target nominal interest rate at under zero percent.
• Formally set negative rates have been found in practice following the 2008 financial crisis in several purviews like in parts of Europe and in Japan.