NIRP stands for “Negative Interest Rate Policy.”
NIRP is a macroeconomic concept that describes conditions characterized by negativenominal interest rates.
The central bank adopted unconventional monetary policy and set the target interest rate below 0%.
Therefore, under negative interest rates, the price of money is not zero. is less than zero .
This typically occurs once a central bank reaches the zero lower bound (ZLB) of its benchmark interest rate.
Negative interest rates mean that central banks will charge negative interest rates.
The idea is to charge banks for depositing funds with the central bank.
This means the borrower will earn interest instead of paying interest to the lender.
Instead of receiving funds through deposits, depositors must make regular payments to deposit their money in the bank.
In recent years, central banks in Sweden, Denmark, Japan and the European Union have adopted NIRP.
The economic theory behind negative interest rates is that negative interest rates will encourage banks to push money out rather than pay fees to hold it .
Businesses will start investing again and consumers will spend faster rather than paying negative interest rates for holding cash in banks.
Therefore, Aggregate demand will rise.
How does NIRP work?
Interest rate is one of the main levers used by the central bank to adjust monetary policy and maintain economic balance.
The Center raised interest rates to help cushion the economy from the impact of inflation, as higher rates make borrowing more expensive for consumers and businesses.
When a country faces a recession, it lowers interest rates because it encourages borrowing and spending, thereby stimulating the economy.
Historically, when you applied for a loan, you paid more than the amount you originally borrowed due to accrued interest.
However, if interest rates are negative, the process reverses itself.
If you take out a loan at a negative interest rate, you won’t have to pay interest on the amount you borrow. Instead, the lender will pay you .
With negative interest rates, you end up paying back less than you borrowed, so you make money in the long run.
If you have a savings account with a bank, , you will pay the bank’s fee for keeping your money.
The central banks currently pursuing negative interest rate policies are simply imposing them on commercial banks.
Here’s how NIRP will impact consumers:
- If you deposit $10,000 into a one-year CD at 1% interest, your initial deposit will be worth only $10,100 by the end of the year, and earns $100Extra purchasing power.
- If you put $10,000 into a one-year negative 1% CD, your initial deposit would be worth only $9,900 at the end of that year.
Negative interest rates are not a reaction to specific economic events.
Instead, central banks use negative interest rates to encourage those holding cash on short-term government bills to move their funds to other (hopefully) more productive areas of the economy.
Because you lose value due to negative deposit rates, NIRP discourages hoarding of cash.
Designed to incentivize banks to lend more freely, and businesses and individuals to invest, borrow and spend, rather than paying fees to keep their money safe.
Charging people to deposit cash in banks is intended to encourage people to spend , thereby putting money back into the economy.
In theory, negative interest rates encourage people to buy homes, use credit cards, and take out other types of loans. By increasing their spending, people will help the economy.
What is the purpose of NIRP?
NIRP is designed to fight deflation.
During an economic downturn, people often hold on to their money and wait to see some kind of improvement before they start spending.
Therefore, Deflation is likely to become entrenched in the economy.
Deflation is a decrease in the overall price level of goods and services.
When people stop or reduce spending, demand for goods and services drops, and people wait for lower prices before spending.
For example, if you want to buy a TV but think it will be cheaper tomorrow, you will postpone the purchase today. Then tomorrow comes and you think it will be cheaper the next day, so you put it off again. The next day comes...
This can become a vicious cycle, and it can be very difficult to break.
Negative interest rates fight deflation by making it more expensive to hold or hoard money, basically, forcing you to spend money ("use it or lose it").
At the same time, negative interest rates make borrowingmoney attractive because banks pay you to do so
Risks of NIRP
Here are the risks posed by NIRP:
- Negative interest rates (NIRP) force investors and money managers to chase yield (seeking positive returns on capital). This requires taking on higher risk, as higher yields are a direct result of higher risk. The risk an investor takes can be an order of magnitude greater than the rate of return. This phenomenon is called "chasing yield."
- To generate fees in a negative interest rate world, lenders would have to make large loans to marginal borrowers (borrowers who would not qualify for loans in more prudent times). This forces lenders to either forego loan income or take on significant risk in lending to marginal borrowers.
- The income that traditional savers once earned has been completely destroyed by negative interest rates, depriving the economy of a key source of income.
Federal Reserve Chairman Jay Powell has gone to great lengths to dispel the idea that negative interest rates are being considered, but one thing he hasn’t done is categorically close the door to their use.
He expressed doubts about the effectiveness of these measures and said they were not suitable for the U.S. economy.
NIRP could also wreak havoc on the banking industry and money market funds. However, if all other tools so far fail, negative interest rates must remain on the table.
Negative market interest rates are possible in the United States, and likely will be at some point.
The only question is whether the Fed endorses negative interest rate policy.
Central bankers are reluctant to do so, but they cannot rule it out if markets force their hand and other policy tools prove insufficient.
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