Is a negative interest rate unorthodox? Yes. But it is not that unusual. First implemented by the Swiss government in 1970, this monetary policy was adopted again after the GFC by Sweden, Switzerland, Denmark, and even the entire Eurozone to fight the recession. Now, the policy catches everyone’s attention again when the Bank of Japan (BoJ) announced on the 29th of January their plans to implement a negative interest rate policy to help ease the economic tension in Japan.
Negative interest rate could be seen as a penalty interest rate imposed by central banks on those commercial banks who are reluctant to lend their money to the real economy or large firms holding much cash without investing it. It is not a punishment for the retail saver at all. Conversely, a negative interest rate can also be thought of as a tax on saving (Buiter, 2003). Technically, this encourages people to consume more and firms to invest more and in this way prevents a full-blown deflationary spiral. However, in practice, the policy appears to have many potential pitfalls and problems. While there are supporters on both sides of the fence, this article will try and attempt to analyse the expected impact and usefulness of the policy specific to the Japanese economy.
Japan is facing a so-called ‘3-D challenge’ – debt, demographics and disinflation (Curran, 2016). To pull Japan out of its decades-long deflationary slump, Prime Minister Shinzo Abe has listed fiscal spending as one pillar of his “three arrows” plan (which includes fiscal stimulus, monetary easing, structural reform). However, the country has already piled up an extraordinarily high public debt, which in mid-2015 reached about 245% of the country’s annual GDP. With present settings unchanged, the public debt level will climb up to around 290% of its GDP by 2030 (IMF, 2015). IMF has pointed out that “Japan’s public debt is unsustainable under current policies” (Yan, 2015).
Despite being the world’s third-largest economy, Japan is the fastest aging country in the world (The Economist, 2014). So how does its demographics look? 25.8% of Japan’s population is above 65 in 2014, and 32.2% are expected to be senior citizens by 2030 (Brandon, 2014). Even worse, the latest 2015 census has shown Japan’s total population had shrunk 0.7% since the last census in 2010 (Panda, 2016). The aging problem will require larger social welfare spending and create labour shortages which are detrimental to the economy’s recovery.
Another question to ask is how is Abenomics (the economic policies advocated by Shinzō Abe ) going since the prime minister’s ‘Japan is back’ claim in 2012? So far, not so good. Despite massive fiscal and monetary stimulus, Japan’s inflation remains well below the Bank of Japan’s 2% target. Headline consumer inflation in January is 0% (Emily Cadman, 2016). Meanwhile, the Japanese economy shrunk by 0.3% in the last quarter and private consumption declined heavily by -0.9% quarter on quarter (Japan Macro Advisors Inc., 2016).
Thus, amid the recent stock slump and currency appreciation pressure, the sub-zero rate is merely another injection provided for the country’s ailing economy, trying to spur inflation and to suppress the strengthening yen. So, how are the negative interest rates expected to help the ‘three-arrow’ Abenomics succeed the 3-D challenges?
Japan wants and needs to rekindle inflation to promote growth. This can be achieved through printing more money, spurting more demand and lowering interest rate.
These are exactly the strategies BoJ has taken, but so far the effects are still far from expected. Hence, the BoJ has decided to enact the negative interest rate policy, part of BoJ multi-tier interest rate regime – Bank of Japan’s Quantitative and Qualitative Monetary Easing with a Negative Interest Rate (QQE with NIR).
How does it work?
The outstanding balances of financial institutions’ current accounts held at the central bank are divided into the three tiers:
| Basic Balance: positive interest rate of 0.1% |
| Average outstanding balance of current account, which each financial institution held during benchmark reserve maintenance period from January 2015 to December 2015 |
| Macro Add-on Balance: zero interest rate (0%) |
| · Amount outstanding of the required reserves |
| · Amount outstanding through the Loan Support Program and the Funds-Supply Operation to Support Financial Institutions in Disaster Areas affected by the Great |
| · Balance calculated as a certain ratio of the amount outstanding of its basic balance |
| Policy-Rate Balance: negative interest rate (-0.1%) |
| Outstanding balance of each financial institution’s current account at the Bank of Japan in excess of Basic Balance and Macro Add-on Balance (see above) combined |
| Source: Bank of Japan |
From 16 February 2016, the BoJ started to charge commercial banks 0.1% interest on some reserves whilst the additional reserves were held by the BoJ. The existing reserves, which now total a record ¥220 trillion ($1.8 trillion USD), will continue earning 0.1%. Nonetheless, due to the on-going quantitative easing (QE), there will be plenty of those new reserves (The Economist, 2016).
The policy is aimed to punish banks from hoarding money instead of lending the deposits to businesses and households. It encourages companies and banks to invest in the real economy, thus to accelerating economic growth. In theory, an interest rate below zero will reduce the borrowing cost for companies and households; therefore an increase in the demand. Will this hurt the banks? Yes. However, if the policy succeeds the banks will also benefit from the policy in the long run.
The introduction of negative interest rates has nonetheless been met with widespread scepticism. Its announcement drove down the value of the Yen and briefly buoyed Japanese share prices as intended. However, these positive effects were short lived as later Japanese banks were hit harder than expected. Unable to pass on negative rates to savers, their stock prices began plunging resulting in a global sell-off. This reaction was not single-handedly the result of a negative interest rate but more so a result of its combination with macro factors, such as a global oversupply of commodities, falling oil prices, U.S. rate hikes, and the slowing rate of growth in China (Sano and Kihara, 2016). Besides this, whilst still in its early days, Banks have not let rates fall below zero as of yet because they have had very little time to incorporate the idea of a negative interest rate into its trading systems between its announcement and implementation (Sano and Kihara, 2016). However, the race to do so is on as banks stand to lose more in taking its time.
Another group that are gravely affected by negative interest rates are insurance companies and pension funds. Both types of companies typically would have a high proportion of long-term fixed rate or fixed amount of liabilities to pay out. Where their money is invested in many high quality fixed income products that are now trading at negative yields, it becomes increasingly difficult for them to meet their payment obligations (Finger, 2016). Effectively, Japan does not stand a chance of sustaining such negative interest rates without it causing irreparable damage to both the insurance and pension funds industry. Moreover, situations like these do nothing for consumer confidence and instead are sending specific groups of people, particularly retirees into a frenzy over the security of their financial future.
In conclusion, in theory the new policy seems ideal – not only are banks encouraged to provide more funds to businesses to invest, the average daily consumer is not penalised either. However, in actuality, we can see that whilst the negative interest rates do not directly penalised the average Japanese consumer, the spill over effects are no less real. Nonetheless, the question with greater importance at this time is not whether the adoption of negative interest rates is a good policy, but whether it is better than the other options that the BoJ has at this point in time. We believe that while we would still have to observe the market movements a little more, it is possible that a short-mid term policy would help to spur the highly developed Japanese economy.
References
Brandon, E. (2014, June 16). 10 Rapidly Aging Countries. Retrieved from U.S. News & World Report: http://money.usnews.com/money/retirement/slideshows/10-rapidly-aging-countries/2
Curran, E. (2016, February 18). Debt, Demographics and Disinflation: Japan’s 3-D
Lessons for Asia. Retrieved from Bloomberg Business: http://www.bloomberg.com/news/articles/2016-02-18/debt-demographics-and-disinflation-japan-s-3-d-lessons-for-asia
Emily Cadman, R. H. (2016). The Japanese economy at a glance. Retrieved from
Financial Times: https://ig.ft.com/sites/numbers/economies/japan
IMF. (2015). IMF Country Report No. 15/197. Washington, D.C.: IMF.
Japan Macro Advisors Inc. (2016, March 8). Japan Gross Domestic Product. Retrieved from Japan Macro Advisors: http://www.japanmacroadvisors.com/page/category/economic-indicators/gdp-and-business-activity/gdp/
Nikkei Asian Review. (2016, March 13). Japan looks to fiscal spending as monetary policy sags. Retrieved from Nikkei: http://asia.nikkei.com/Politics-Economy/Economy/Japan-looks-to-fiscal-spending-as-monetary-policy-sags
Panda, A. (2016, February 27). It’s Official: Japan’s Population Is Still Declining. Retrieved from The Diplomat: http://thediplomat.com/2016/02/its-official-japans-population-is-still-declining/
The Economist. (2014, March 25). The incredible shrinking country. Retrieved from http://www.economist.com/blogs/banyan/2014/03/japans-demography
Wearden, G. (2016, February 12). Global stocks enter bear market after another rout – as it happened. Retrieved from The Guardian: http://www.theguardian.com/business/live/2016/feb/11/market-turmoil-hong-kong-europe-ftse-banks-yellen-live?page=with:block56bcb022e4b0d007e4723bd9#block-56cb022e4b0d007e4723bd9
Yan, S. (2015, July 24). IMF warns Japan over its staggering national debt. Retrieved from CNN Money: http://money.cnn.com/2015/07/23/news/economy/japan-debt-imf/
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