Zero-Bound Interest Rate

When we’re talking ‘zero bound interest rate,’ we’re talking monetary policy: which is mostly the Fed tinkering with interest rates it charges banks and the amount of USD floating about. FWIW, the zero bound interest rate is seen as a myth now, but only in recent times since it’s been tested.

Not too long ago, the Fed assumed that changing short-term interest rates (for money that banks borrow from the Fed) to 0% was as far as they could go to stimulate the economy. The further interest rates went down, they thought, the less effect the Fed would have on the economy. Most likely, they just didn’t want to go into the negative-interest-rate zone, because that means the tables would be turned: banks would be gaining interest from depositors, not paying interest to depositors. This is called Negative Interest Rate Policy, or NIRP, or a funny way of saying “nope.” It means you’d get charged for the money sitting in your bank account instead of gaining interest on it. Crazytown.

What happens is that consumers are more likely to take their money out of the bank, and hopefully either spend it or invest it, rather than pay to leave it sitting in the bank.

The zero bound interest rate theory was tested when the economy got really bad in 2008. The European Central Bank tried out a negative rate policy on overnight lending in 2014. Japan kept its interest rates around zero for a long time, eventually heading into negative interest rate territory in 2016. While it’s hard to figure out how much of an effect negative interest rates had on the economy, it does look like negative interest rates had some effect in boosting the economy.