NIRP, or "negative interest rate policy," is a macroeconomic concept that refers to situations where nominal interest rates fall below zero. This occurs when central banks implement unconventional monetary policies and set target interest rates that are less than 0%. Under NIRP, the cost of borrowing money is not zero; it is negative. This typically happens when a central bank has reached the zero lower bound (ZLB) in its benchmark interest rate.

A negative interest rate implies that the central bank charges negative interest, meaning banks that deposit their money with the central bank incur a fee. Consequently, borrowers receive interest instead of paying it to lenders. Instead of earning interest on deposits, depositors must pay to keep their funds in the bank. In recent years, central banks in Sweden, Denmark, Japan, and the European Union have implemented NIRP. The underlying economic theory is that negative interest rates will motivate banks to lend more freely rather than pay a fee to hold onto cash. This, in turn, encourages corporations to invest and consumers to spend, thereby increasing overall aggregate demand.

How does NIRP function? Interest rates are a primary tool that central banks use to adjust monetary policy and maintain economic stability. Central banks raise interest rates to combat inflation, as higher rates make borrowing more expensive for consumers and businesses. Conversely, they lower interest rates during a recession to stimulate borrowing and spending, which can help revive the economy. Traditionally, when taking out a loan, borrowers pay back more than the amount borrowed due to interest. However, with negative interest rates, this process is reversed. If you take out a loan at a negative interest rate, you do not pay interest; instead, the lender pays you. As a result, you would repay less than you borrowed, effectively earning money over time. If you have a savings account, you would incur a fee for keeping your money in the bank.

Currently, central banks implementing NIRP have only applied it to commercial banks. For example, if you invest $10,000 in a one-year certificate of deposit at 1% interest, your total at the end of the year would be $10,100, providing you with an additional $100 in purchasing power. However, if you invest the same amount at a negative 1% interest rate, your total would drop to $9,900 after one year. Negative rates are not a reaction to a specific economic event; rather, central banks use them to encourage those holding cash in short-term government notes to invest in more productive areas of the economy. By imposing negative deposit rates, NIRP discourages cash hoarding and aims to motivate banks to lend more freely, while also encouraging businesses and individuals to invest and spend their money instead of paying to keep it safe. The goal is to stimulate economic activity by promoting spending on homes, credit cards, and various loans.

What is the purpose of NIRP? The primary aim of NIRP is to combat deflation. During economic downturns, people tend to hold onto their money, waiting for improvements before they start spending again. This behavior can lead to entrenched deflation, which is a decline in the general price level of goods and services. When spending decreases, demand for goods and services falls, prompting consumers to wait for even lower prices before making purchases. For instance, if you want to buy a TV but anticipate a lower price tomorrow, you may delay your purchase. This cycle can become self-perpetuating and difficult to break. Negative interest rates counteract deflation by making it costly to hoard money, effectively pushing individuals to spend (“use it or lose it”). At the same time, negative rates make borrowing more appealing, as the bank pays you to borrow money.

Risks of NIRP include the following: Negative interest rates compel investors and money managers to seek higher yields, which often involves taking on greater risks. This phenomenon, known as "yield chasing," can lead investors to assume risks far exceeding the potential returns. To generate income in a NIRP environment, lenders may need to extend loans to marginal borrowers—those who would not qualify for loans under more cautious lending practices. This situation forces lenders to either forgo income from lending or take on significant risks. Additionally, the income that conventional savers once earned has been largely eliminated by NIRP, depriving the economy of a crucial income source.

As for NIRP in the U.S., Fed Chairman Jay Powell has made it clear that negative interest rates are not currently being considered, although he does not completely rule them out. He expresses skepticism about their effectiveness and suggests they would not be suitable for the U.S. economy. However, NIRP could disrupt the banking sector and money market funds. If all other monetary tools fail, negative interest rates may need to remain an option. While negative market rates could occur in the U.S., the key question is whether the Fed would endorse a negative interest rate policy. Central bankers would be reluctant to adopt such measures, but they cannot dismiss the possibility if market conditions necessitate it and other policy options prove insufficient.