Implementation of Negative Interest Rate Policy in Japan

By Mitsalina Choirun Husna

Japan has been facing stagnation for almost two decades. This is marked by
how slow the growth of the economy has been. By 1998, Japan's public
works projects still could not stimulate demand enough to end the
economy's stagnation. In desperation, the Japanese government undertook
"structural reform" policies intended to wring speculative excesses from the
stock and real estate markets. Unfortunately, these policies led Japan into
deflation on numerous occasions between 1999 and 2004. Japan used
another technique called Quantitative Easing. As opposed to flooding the
money supply with newly printed money, the Bank of Japan expanded the
money supply internally to raise expectations of inflation. Initially, the policy
failed to induce any growth, but it eventually began to affect inflationary
expectations. By late 2005, the economy finally began what seems to be a
sustained recovery. GDP growth for that year was 2.8%, with an annualized
fourth quarter expansion of 5.5%, surpassing the growth rates of the US
and European Union during the same period. Unlike previous recovery
trends, domestic consumption has been the dominant factor of growth.
Despite having interest rates down near zero for a long period of time, the
Quantitative easing strategy did not succeed in stopping price deflation
which has been the main issue of Japans economy. So Bank of Japan
announced in January that they would implement negative interest rate in an
attempt to save Japans sinking boat.

Negative interest rate policy is an unconventional monetary policy tool

whereby nominal target interest rates are set with negative value, below the
theoretical lower bound of zero percent. During deflationary periods, people
and businesses hoard money instead of spending and investing. The result is
a collapse in aggregate demand which leads to prices falling even farther, a
slowdown

or

halt

in

real

production

and

output,

and

an

in unemployment. A loose or expansionary monetary policy is

increase
usually

employed to deal with such economic stagnation. However, if deflationary

forces are strong enough, simply cutting the central bank's interest rate to
zero may not be sufficient to stimulate borrowing and lending. A negative
interest rate means the central bank and perhaps private banks will charge
negative interest: instead of receiving money on deposits, depositors must
pay regularly to keep their money with the bank. This is intended to
incentivize banks to lend money more freely and businesses and individuals
to invest, lend, and spend money rather than pay a fee to keep it safe. The
question would be, is it effective to be implemented in Japan?
The reason why Bank of Japan is implementing negative interest policy is
because traditional policy options to increase inflation rate such as printing
more money and spurting more demand have proved ineffective and new
limits need to be explored. Increasing inflation rate becomes so important in
Japan because inflation reduces the burden of debt. Japans enormous
government debt represents the governments promise to transfer resources
from young people (who work and pay taxes) to old people (who own

government bonds). Since Japan is an aging society, there are more old
people than young people. That makes the burden especially difficult to bear.
Young people also tend to have mortgages, the repayment of which is
another burden. Sustained higher inflation would represent a net transfer of
resources from the old to the young. That would increase optimism, and
hopefully raise the fertility rate, helping with demographic stabilization. It
would also decrease the risk that the Japanese government will eventually
have

to

take

extreme

measures

to

stabilize

the

debt. How

does

implementation of negative rate policy could increase inflation rate?

Japans economy has been so dependent on automobile manufacturing and
also electronics goods industry. Japan is the third biggest producer of
automobiles in the world. Toyota is currently the world largest car maker, and
the Japanese car makers Nissan, Honda, Suzuki, and Mazda also count for
some of the largest car makers in the world. The Japanese electronics
industry is the largest consumer electronics industry though the share of
these Japanese companies gradually declined by competition from South
Korea and Taiwan. Japan still has a number of companies that produce
television, camcorders, audio and video players, etc. seeing how much
beneficial these sectors are, we would think that it would boost Japans
economy but in reality they are not enough. Japan needs other sector to
grow as well in order to help sustaining then economy. The problem is that,
sectors aside from automobile manufacturing and electronic industry are
having a hard time to start up their business. Commercial banks have

unwillingness to give loans to other sectors because they believe that the
return that they will get by giving loans to other sectors would not be as
great as giving it to automobile manufacturing sector and also electronic
industry sector. So, instead of giving loans to other sectors who might need
the money, the commercial banks prefer to keep the money in central banks.
With the implementation of negative interest rate policy in Japan, Bank of
Japan would charge commercial banks with -0,1% for keeping their money
overnight. Since commercial banks goals are to reap as much profit as
possible, they would take their money off of the Bank of Japan and hopefully
would give incentive for the commercial banks to give loans to other sectors
since keeping the money on the central bank would disadvantaged them
anyway. However, would these other sectors are willing to borrow loans from
commercial banks?
When a central bank changes the policy rate, it is not the rate itself that
affects the economy, but rather the consequences it has been on general
financial conditions. For example, monetary policy has an effect by cutting
both deposit and lending rates to households and companies. When the
policy rate is sufficiently negative, there is therefore reason to believe that
the impact on the economy will weaken since it seems as though the banks
choose not to charge negative interest on their customers deposit accounts.
As long as market rates and lending rates continue to fall, the impact will
basically be normal. Such a development is, however, not sustainable for the
banks in the long term. If lending rates continue to follow the policy rate

down, the profitability of the banks will sooner or later come under pressure.
It is then possible that the banks will start compensating by decreasing their
profit margin. However, when profitability comes under sufficient pressure, it
cannot be ruled out that banks will also allow both deposit and lending rates
to fall below zero, thus helping to restore their profitability.