No Interest for Negative Interest: Japan’s Negative Interest Rate Problem
The year was 2016.
On the 29th of January, the Bank of Japan (BoJ) decided to implement a policy that, until then, had only been seen in a few Nordic nations, ‘The Negative Interest Rate Policy’.
This policy intend that the BoJ impose a nominal interest rate of -0.1% on certain reserves being held by commercial banks.
By February 2016, the BoJ fully adopted the negative interest rate policy by hugely augmenting money supply via the purchase of long-term Japanese Government Bonds (JGBs). This was their attempt at revitalizing a growingly sluggish economy.
However, come 2023, many economists have come to believe that the end of this policy is in sight, even as early as 2024. While debate is ongoing about the effectiveness of the policy, it can largely be concluded that the implementation of negative interest rates in Japan did not have the intended effects at the intended scale.
Why?
To understand this, one must start at the very beginning.
What was happening in Japan?
Japan’s current economic situation is quite complicated- what a McKinsey report from 2000 rightly called a “dual economy”.
One section of the economy showcases Japan’s world-class abilities in the production of automobiles, consumer electronics and the like, while the other comprising of the majority of domestic companies are severely mismanaged and painfully unproductive, dragging the nation’s economy down with them.
But that wasn’t all.
One of the major quandaries that the Government of Japan faced was that the country’s population was ageing.
With an increasing median age and more and more people growing old each year, Japan’s aggregate demand had taken a hit in the last two decades. Consumption levels had declined for both households and firms.
Despite Japan being the world’s third largest economy, the decreased consumption levels were a clear indicator of the worsening of the domestic economy.
Some part of these consumption trends could be attributed to the weakening of the Japanese Yen. The nation’s heavy dependence on imports of food and energy, coupled with decades-long lows against the US Dollar have increased costs domestically, with the Japanese witnessing unprecedented rates of inflation. Japan’s monetary policy has only added to the woes of the economy. The depreciation of the Yen was perpetuated by the government maintaining very low interest rates for years in spite of other nations increasing them.
Another problem as a result of the ageing population is that there are less workers to produce goods and less individuals to consume said goods. No policy targeting corporate governance or employment restructuring would work unless there simply were more people. Profits earned by firms and wages paid to workers have been depressed for decades and Japan’s economic growth has been very slow. With the country’s debt piling, problems would only show signs of worsening unless action was taken to correct these trends at the earliest.
How did Japan tackle these problems?
On 29th of January 2016, the BoJ announced a move to impose an interest rate of -0.1% on excess reserves that commercial banks hold at the central bank. This policy was part of the Quantitative and Qualitative Easing (QQE) programme.
According to the Bank, there are two vital components to this policy framework:
- Yield Curve Control: wherein the Bank controls short-term and long-term investment rates via government operations;
- Inflation-shooting overcommitment: the Bank commits itself to expanding the monetary base until the YoY rate of increase in the observed CPI exceeds the price stability target of 2%, which was set in 2013, and stays above this target in a stable manner.
It meant that commercial financial institutions would have to pay a fee on increments to reserve deposits with the central bank.
This move was meant to incentivise banks to store less money as deposits and increase their lending via the provision of cheap credit to individuals and firms who need it. This would motivate an increase in consumer expenditure, boosting corporate entities, creating employment, all built on an augmentation in domestic demand.
This was their crown jewel in a policy that sought to combat the deflationary pressure that caused Japanese economic growth to slow down.
This move came as a shock to most parties and was understandably not well received.
This policy was part of reforms under Abenomics, the name of expansionary economic reform policies propagated by the then Prime Minister of Japan, Shinzo Abe. Several news articles published in January and February of 2016 expressed the general hesitation that economists were feeling upon the announcement. The Negative Interest Rate Policy (NIRP) is one of several Unconventional Monetary Policies (UMPs) that have begun to be adopted by some advanced economies when their growth hits a plateau.
When the BoJ announced the policy, the value of the Yen drove down and the values of Japanese share prices rose. However, these effects were very short-term, because the market saw a complete reversal almost immediately.
The Other Side of Coin of Consequence
While plenty of minor reasons snowballed into the situation that is the failure of the NIRP, there seem to be two major reasons for this result- a lack of preparation time for banks to ease into this policy and Japan’s over-reliance on the NIRP as the sole harbinger of progress.
The initial days of the policy implementation spelled only bad news for the Japanese economy. Within the first fortnight of the announcement, the Nikkei index had fallen by 8.5%, Japanese bank shares had declined by 30% and Japanese banks were being pushed to operate with 8-15% decrease in profit levels.
The move, being completely unprecedented, did not allow banks sufficient time to prepare for such a change as they did not want to pass on negative interest rates to savers. The Japanese public was already quite dissatisfied with the meagre interest rates that banks were offering on savings, and to now force them to pay up to deposit with the bank would trigger an immense outcry.
Japan also failed to complement the NIRP with other policies that aimed at revitalising the country’s economy. Considering the programme to be a one-stop shop, they failed to properly analyse and implement other reforms that would target the fields of productivity, employment, digitization and the like. By simply pushing interest rates to levels below zero, the Government may be able to incentivise people to withdraw their money from commercial institutions, but it still cannot motivate them to spend their money rather than hoard it. If such a situation persists for a prolonged period of time, commercial banks would no longer be profitable ventures and would be forced to shut down, effectively ending the cycle of credit creation and production in the economy, ultimately killing it.
Focusing on old Female Labour would have been helpful.
UMPs are not the only available tool to push the third-largest economy into a period of growth. The Government of Japan has recognised the need for reforms and restructuring in the field of government employment as a way to tackle the unemployment crisis. While long-term incentives to increase birth rates are the need of the hour, the country can make moves to integrate more older and female workers into the force as a way of boosting the country’s productivity in the current demographic situation. Renewed policies of corporate governance can be instrumental in motivating workers to increase their efficiency and productivity, raise their wages, boost firm profits and thus motivate both firms and individuals to consume more, increasing aggregate demand as desired.
While the policy is ingenious and its true effects are difficult to put to scale, the BoJ still continues to have some hope in the NIRP. While some sources have hinted that the Bank of Japan may see a decision regarding this policy in January 2024, most agree April to be the actual deadline to see any real decisions being made in this regard. Regardless, Japan keeps moving towards the horizon of the rising sun, their goals, clearly in sight. For the Bank, this is the stable, sustained level of 2% inflation, while for the government, it is the revival of one of the world’s strongest economies.
Aarya Pillai
Aarya Pillai is a research intern with Tatvita Analysts pursuing her graduation in Economics from Gokhale Institute, Pune. She has keen interest in researching on international relations and food security as a policy matter.
Very well written article by Arya Pillai