Zero interest rate policy - Definition and Overview

The zero interest rate policy (ZIRP) is a macroeconomics scheme devised by economist Paul Krugman for economies exhibiting slow growth with a very low interest rate, such as contemporary Japan. Krugman's thesis is that these countries are in the so-called liquidity trap, even though common neoclassical economics disagrees.

Under ZIRP, the central bank maintains a 0% nominal interest rate, and then maintains inflation of the currency to make the value of otherwise stable investments, such as real estate, rise over time. It is effectively a way of imposing a negative interest rate.

For instance, with a 0% interest rate and 4% inflation rate, a house or commercial property will appreciate in value by 4% a year. This means that the return on the investment is calculated as if the interest rate is actually -4%.

The effect of a ZIRP policy is to encourage investment throughout the economy by making capital purchases more financially attractive. It is a new Keynesian policy and one, that the core of the common neoclassical economics rejects as working. The subject is under much debate.