Under ZIRP, the
central bank maintains a 0%
nominal interest rate. The ZIRP is an important milestone in
monetary policy because the central bank is typically no longer able to reduce nominal interest rates. ZIRP is very closely related to the problem of a
liquidity trap, where nominal interest rates cannot adjust downward at a time when savings exceed investment. However, some economists—such as
market monetarists—believe that unconventional monetary policy such as
quantitative easing can be effective at the zero lower bound. Others argue that when monetary policy is already used to the maximal extent, governments must be willing to use
fiscal policy to create jobs. The
fiscal multiplier of government spending is expected to be larger when nominal interest rates are zero than they would be when nominal interest rates are above zero.
Keynesian economics holds that the multiplier is above one, meaning government spending effectively boosts output. In his paper on this topic,
Michael Woodford finds that, in a ZIRP situation, the optimal policy for government is to spend enough in stimulus to cover the entire
output gap. Chris Modica and Warren Sulmasy find that the ZIRP policy follows from the need to refinance a high level of
US public debt and from the need to recapitalize the world's banking system in the wake of the
2008 financial crisis. ==Zero lower bound==