Japan’s Negative Interest Rate Story

Bank of Japan in Chūō, Tokyo

Central Banks around the world have wrestled with low-interest rates, but nowhere have they grappled with them for longer than in Japan [5]. Investment in Japan as a percentage of GDP has been on a downward trend for more than two decades. To combat these persistent bouts of deflation, the Bank of Japan (BoJ) pioneered a monetary strategy known as “quantitative easing” (QE). The main function of QE is to depress long-term interest rates by buying vast amounts of government bonds through printed currency [1].

Employing this technique led the BoJ to introduce negative interest rates in January 2016. Although this was 20 months after negative rates were first issued by the European Central Bank (ECB), Japan had already faced stagnated interest rates, reaching as low as 0%, since 1999 [5]. Prior to entering 2017, Japan once again reviewed their monetary policy in hopes to kick-start growth, as intended for the past two decades. After the two-day policy meeting in December 2016, the BoJ left that policy unchanged, planning to: maintain the negative 0.1% interest rate on excess bank reserves, leave the 10-year Japanese Government Bond (JGB) at a yield target of 0 bps, and keep annual rises in JGB holdings to 80 trillion yen (676.9 billion USD) [4].

The implications of negative interest rates mean depositors must pay money to set aside reserves, which is a reversal of the common understanding of economics [1]. Depositors are commonly known as banks, and their relationship with the Central Banks are similar to regular people who keep accounts at a local bank. This relationship normally allows depositors to receive a small amount of interest in return for leaving their money with the Central Bank. However, with the introduction of negative rates, Central Banks charge depositors a negative rate on principal kept in excess reserves. This strategy is meant to encourage the productive utility of money for depositors by lending more frequently to consumers and businesses. Negative rates are then supposed to send a ripple effect through the economy by lowering the cost of borrowing for everyone – which should in turn stimulate economic growth [1].

Japan’s core inflation rate since 1971.

Japan has been dealing with low-interest rates since 1995, never moving higher than the 0.5% rate which was slashed to zero in 1999. Despite the lower borrowing costs, consumer demand has weakened, which created deflationary pressure on the country [2]. “There should be some threshold where corporations will start to take cash out of their vaults and put it to work,” said Masaaki Kanno, Japan chief economist at J.P. Morgan. The solution the BoJ seeks is to drop its benchmark rate further, in an attempt to trigger inflation. It is conceivable that rates may drop to as low as -0.7% [2].

The greatest difficulty the BoJ now faces is timing. As the U.S. Federal Reserve announced their first of several rate hikes in 2017, the consequences are still unknown for Japan. Additionally, the yen has tumbled 10% percent post-U.S. election. A weaker yen generates inflationary pressures through higher import costs and greater corporate profits: in turn this diminishes the effectiveness of Japan’s monetary policy [3]. A premature rate hike might risk increasing the strength of the yen, making it much more difficult to reach the inflation target. As Heizo Takenaka, a professor at Toyo University and Japan’s former Minister of State for Economic and Fiscal policy puts it best, “Despite the criticisms of negative interest rates, Japan lacks alternatives” [2].

[1] https://www.nytimes.com/2016/09/21/business/international/japan-boj-negative-interest-rates.html
[2] http://business.financialpost.com/news/economy/japan-in-transition-rest-of-world-watches-as-country-tries-negative-interest-rates-to-spur-economy
[3] https://www.bloomberg.com/news/articles/2016-12-20/boj-keeps-policy-unchanged-as-weak-yen-brightens-price-outlook
[4] http://www.cnbc.com/2016/12/19/bank-of-japan-holds-rates-steady-as-expected-kuroda-press-conference-awaited.html
[5] http://www.economist.com/news/finance-and-economics/21712134-biggest-lenders-can-largely-shrug-negative-rates-many-smaller-ones