By Sandhya Kumari

Registration No 1366113

Reasons for negative interest rates in Japan

Negative interest rates and dysfunctional economy, almost less than 1% growth
rate in Japan along with deflation is being referred as Lost Decade. Following are
the factors that contributed to explain this lost decade in Japan. A high of 38957
points recorded in December 1989, the Japanese Index had fallen to 6994 by
October 2008 which is about 82% decline over 19 years. But Japans lost decade
wasnt just related to stocks. Economic growth became stagnant in the 1990s.
Worst of all, with house prices slumping, Japanese firms retrenching and personal
consumption was going off, Japan entered a deflationary spiral and despite Japan
economy was facing near zero interest rates.
Burst bubble-(1991-2010 referred as last two decades)
The bubble period occurred during 1985-90 as economy had non performing
loans which led to the crisis in the banking sector. Because of this monetary
policy became powerless in 1990s.The land price index and stock price
index four times declined from 1983 to 1989.
Growth ended at the start of 1990s.In the late 1980s, credit was easy to attain
but the investment lacked the quality. Japan banks started to lend more and
did not consider the quality of borrower and this led to inflate the bubble
economy. Asset prices collapsed by early 1992.This results in decline in the
economy and huge accumulation of non performing asset loans started to
gather. This was causing difficulties for financial institution.

Overconfidence and Increase in Stock index and Land prices

Overconfidence along with the bank of Japan's loose monetary policy during mid
of 1980s which led to aggressive speculation in the stocks and real estate, this
pushed the prices of these assets at peak levels which were unimaginable. The
crash occurred and competitive edge were deteriorating against Asian exporters.
Then Bank of Punjab decided to tighten the monetary policy.
Fiscal Policy Mistake
A fiscal mistake was made when the consumption tax rate increase and repeal
income tax cut is made in April 1997.
Slow structural reform in regulated sectors is another problem for the Japanese
economy which has not benefited from information and communication
technology advances that propelled the US economy
Failure of Monetary Policy
Most likely cause for deflation in Japan is a failure of monetary policy. Interest rate
was lowered to zero in 1999 and 2001 in false expectation of continuing economic
expansion though government and many economists did the protest. As real estate
values were abnormally appreciating, Central bank (Bank of Japan) continued to
raise interest rate. This contributed to the end of rising land prices but economy
was declining. For this, Bank of Japan take the reverse course and cut the interest
rates. But it was too late both liquidity trap and credit crunch set in the economy.
Many of the firms failing and burdened with heavy debts and it became difficult to

get credit. Official interest rate was 0.1% as of 2012, since 1994 interest rate
remained below 1%.
Central bank did not know actually whether assets prices rising were due to
fundamentals or due to a bubble. Second mistake carried out by Central bank that
they took high interest rate which further pop up the bubble and real variables then
become more volatile. There was a requirement of supervision policy rather than
monetary policy to get on the financial stability.
In 1999, overnight call rate was lowered to 0.15% this was beginning of zero
interest rate policy in Japan. It was clear from such rate that economy is very weak
state. By that time , GDP was lowered five times.
Banking Crisis (1997-1998)
Banking crisis resulted from slow policy responses to non-performing loan
problem and financial sector in the country then became too weak.
Appendix
Here bubble economy refer to economic bubble which is occurred between the
period from 1986 to 1991 in Japan. During this period, the prices of stock market
and real estate were inflated greatly. This period is characterized by accelerated
asset prices and economic activity were at peak but in the presence of uncontrolled
money supply and credit expansion.

This happened because of over confidence and speculation with regards to stock
prices, they were closely related to the excessive monetary easing policy during
that period. By 2002 the economy and financial institutions weakened again.
Deflationary expectations were setting in, consumption and investment were
depressed. Aggregate demand fell short of potential output, and the widened output
gap depressed prices, reinforcing deflationary expectation.
Many banks and insurance companies were carrying books with full of bad debts.
This means that they kept securities which were near worthless on their books for
years at inflated values. Some of the financial institutions were bailed out by the
government through capital infusion and cheap credit so that recognition of losses
can be postponed.
References
https://en.wikipedia.org/wiki/Japanese_asset_price_bubble
http://www.nber.org/papers/w10878

http://www.thebubblebubble.com/japan-bubble/
http://www.forbes.com/sites/eamonnfingleton/2013/08/11/now-for-the-truth-thestory-of-japans-lost-decades-is-the-worlds-most-absurd-media-myth/