Loading the player...

What is a 'Negative Interest Rate Policy (NIRP)'

A negative interest rate policy (NIRP) is an unconventional monetary policy tool whereby nominal target interest rates are set with a negative value, below the theoretical lower bound of zero percent.

BREAKING DOWN 'Negative Interest Rate Policy (NIRP)'

A negative interest rate means the central bank and perhaps private banks will charge negative interest: Instead of receiving money on deposits, depositors must pay regularly to keep their money with the bank. This is intended 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.

During deflationary periods, people and businesses hoard money instead of spending and investing. The result is a collapse in aggregate demand, which leads to 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 usually employed to deal with such economic stagnation. However, if deflationary forces are strong enough, simply cutting the central bank's interest rate to zero may not be sufficient to stimulate borrowing and lending.

See also: How Interest Rates Can Go Negative.

Theory Behind Negative Interest Rate Policy

Negative interest rates can be considered a last-ditch effort to boost economic growth. Basically, it's put into place when all else (every other type of traditional policy) has proved ineffective and may have failed. 

Theoretically, targeting interest rates below zero will reduce the costs to borrow for companies and households, driving demand for loans and incentivizing investment and consumer spending. Retail banks may choose to internalize the costs associated with negative interest rates by paying them, which will negatively impact profits, rather than passing the costs to small depositors for fear that otherwise they will move their deposits into cash.

For more, see: Negative Interest Rates and QE: 3 Economic Risks.

Examples

An example of a negative interest rate policy would be to set the key rate at -0.2 percent, such that bank depositors would have to pay two-tenths of a percent on their deposits instead of receiving any sort of positive interest.

Though fears that bank customers and banks would move all their money holdings into cash (or M1) did not materialize, there is some evidence to suggest that negative interest rates in Europe cut down interbank loans.  

To stay on top of the latest finance and investing lingo, subscribe to our Term of the Day newsletter.

RELATED TERMS
  1. Negative Interest Rate Environment

    A negative interest rate environment exists when a central bank ...
  2. Zero-Bound Interest Rate

    A zero-bound interest rate is the lower limit of zero on short-term ...
  3. Negative Carry

    Negative carry is a situation in which the cost of holding a ...
  4. Euro Deposit

    A euro deposit is a deposit of foreign currency into a European ...
  5. Low Interest Rate Environment

    A low interest rate environment is when the risk-free rate of ...
  6. Interest Rate

    Interest rate is the amount charged, expressed as a percentage ...
Related Articles
  1. Investing

    How Negative Interest Rates Can Affect Banks' Bottom Lines

    Examine the impacts of low interest rates on banking industry profits and find out if negative interest rates will have a more extreme effect.
  2. Insights

    The Negatives of Negative Interest Rates

    Negative interest rates are taking over the world. Are they a cure or a disease, and will the Fed Chair follow suit?
  3. Investing

    The Negative Rates of Europe's Central Banks

    We are currently seeing negative central bank deposit rates and government and corporate bonds with negative yields, but there are investors buying into these securities. Why?
  4. Insights

    Are Negative Interest Rates Good or Bad?

    The jury is still out on the effectiveness of negative interest rates, and whether they help or hurt the national and global economy.
  5. Investing

    Why Negative Interest Rates Are Still Not Working in Japan

    Japan's negative interest rate policy has failed to generate economic growth, but the central bank keeps trying to print up prosperity.
  6. Insights

    Number of Banks That Charge Clients for Cash Deposits Is Growing

    In August 2016, two years after the ECB's decision to cut rates below zero, a few banks have started charging clients and institutions for large cash deposits.
  7. Personal Finance

    How Banks Set Interest Rates on Your Loans

    Are you planning on getting a loan from bank? Here is the information you need know on how banks set the interest rates to get the best possible deal.
  8. Insights

    10 Countries With Lower Interest Rates Than the US

    Learn about the 10 countries with lower interest rates than the United States and how interest rates indicate a country's economic outlook.
  9. Investing

    Analyzing a bank's financial statements

    In this article, you'll get an overview of how to analyze a bank's financial statements and the key areas of focus for investors who are looking to invest in bank stocks.
  10. Insights

    Open Market Operations vs. Quantitative Easing

    How does the Fed's implementation of Quantitative Easing differ from its more conventional open market operations?
RELATED FAQS
  1. Who determines interest rates?

    Learn who determines interest rates. In countries using a centralized banking model, interest rates are determined by the ... Read Answer >>
  2. What is the relationship between inflation and interest rates?

    As interest rates are lowered, more people are able to borrow more money, causing the economy to grow and inflation to increase. ... Read Answer >>
Trading Center