A negative interest rate policy (NIRP) is when a central bank sets the interest rate below zero. This is a rarely used monetary policy tool sometimes used in deflationary periods.
During deflationary periods, people and businesses hoard money instead of lending, spending, and investing. The result is a collapse in aggregate demand which leads to prices falling even farther. Real production and output slows, and unemployment rises. A dovish monetary policy (lowering interest rates, increasing the money supply by buying financial instruments and bonds, etc.) is usually employed to deal with such economic stagnation. However, if deflationary forces are strong enough, cutting the central bank’s interest rate to zero may not be sufficient to stimulate borrowing and lending.
A negative interest rate means the central bank and private banks will charge a negative interest rate. That means that instead of a depositor receiving money on his/her deposits, depositors instead have to pay regularly to keep their money with the bank. The goal is to incentivize banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe. However, people may instead pull their money out of the bank and choose to keep it in a safe deposit box or an in-home safe (i.e. stuff it under their mattress). That is the risk with negative interest rates and why central banks rarely use them.<< Back to Glossary Index