Zero interest rate

3 key takeaways

• Zero interest rates aim to encourage borrowing and spending to boost economic growth.
• They are typically used during periods of economic recession or deflation.
• Zero interest rates can impact savings, investments, and inflation.

What is a zero interest rate?

A zero interest rate refers to a situation where a central bank, such as the Federal Reserve or the European Central Bank, sets its benchmark interest rate at or close to zero percent. This policy is used as a stimulus measure to encourage economic activity by making borrowing cheaper and saving less attractive. The goal is to increase consumer spending and business investments, which can help pull an economy out of recession or prevent deflation.

Zero interest rate policies (ZIRP) are part of unconventional monetary policy measures. When traditional tools, like lowering interest rates moderately, are insufficient to revive the economy, central banks may resort to setting rates at zero or even implementing negative interest rates.

How does a zero interest rate work?

Zero interest rates work by reducing the cost of borrowing money. Here’s how it typically impacts the economy:

• Encourages borrowing: With lower interest rates, consumers and businesses are more likely to take out loans for big-ticket purchases, investments, and expansions. This increased borrowing can lead to higher consumer spending and business investment, stimulating economic growth.
• Discourages saving: When interest rates are near zero, the returns on savings accounts and other low-risk investments are minimal. This discourages saving and encourages spending, as people seek better returns on their money through spending or investing in riskier assets.
• Reduces debt servicing costs: Lower interest rates reduce the cost of servicing existing debt for consumers, businesses, and governments, freeing up additional funds for spending and investment.
• Affects currency value: Lower interest rates can lead to a depreciation of the national currency, making exports cheaper and more competitive on the global market, which can help boost the economy.

Examples of zero interest rate policies

Zero interest rate policies have been implemented by various central banks during times of economic crisis:

• Federal Reserve (USA): The Fed set interest rates near zero during the 2008 financial crisis and again during the COVID-19 pandemic in 2020 to support economic recovery.
• European Central Bank (ECB): The ECB has maintained interest rates at or near zero since 2014 to combat low inflation and stimulate growth in the Eurozone.
• Bank of Japan (BOJ): The BOJ has kept interest rates near zero or negative since the late 1990s to counter prolonged economic stagnation and deflation.

While zero interest rates can provide short-term economic relief, they also come with potential risks, such as creating asset bubbles, reducing the profitability of banks, and limiting the central bank’s ability to cut rates further in future downturns.

For further exploration, related topics include monetary policy, quantitative easing, negative interest rates, and economic recession. These subjects provide deeper insights into how central banks use various tools to manage economic stability and growth.