By Christopher Chaccour | Junior Editor
Japan was known as the only country in the world still adopting the negative interest rate policy. In March 2024, the Bank of Japan (BOJ) hiked its interest rates for the first time in 17 years, ending the country’s policy and moving the world to a new era: one where negative interest rates are no longer part of the financial landscape. These are the reasons behind this historic decision and its expected effects.
What is a negative interest rate policy?
A Negative Interest Rate Policy (NIRP) is a non-traditional monetary policy taken by the central bank of a country to set target nominal interest rates below 0%. This unconventional approach is used to encourage borrowing, spending, and investment in the country. This is done by charging banks on excess reserves, pushing them to save less and lend out more money. The NIRP is generally used to stimulate the economy during deflationary periods and to prevent further price declines.
In June 2014, the European Central Bank (ECB) was the first major central bank to employ negative interest rates as it was facing deflationary pressures. Other central banks, like those in Denmark and Sweden, followed suit, and so did Japan’s in 2016. The ECB was also the last one to end this policy before Japan, in September 2019.
A summary of Japan’s economy
Japan is the second-largest economy in Asia and the fourth-largest in the world. Its economy is based on manufacturing. It produces and exports motor vehicles, electronics, and high-technology manufactured goods. It also has a solid service sector from finance to tourism. Moreover, it has a robust agricultural sector planting high-value crops such as rice, vegetables, and fruits, resulting in a strong domestic market and reducing the nation’s dependence on trade.
After immense devastation from World War II, Japan witnessed rapid economic growth from 1949 till the 1990s. Afterward, it suffered from a period of stagnation that has persisted. Since the 90s, in an effort to stimulate growth, Japan implemented monetary easing policies such as the ultra-low interest rates. Moreover, in 2016 along with the NIRP, the country also adopted the Yield Curve Control that targets long-term interest rates, which also seems to have been abandoned by the country recently.
Was the NIRP effective in Japan?
The effectiveness of the NIRP in Japan is strongly debated. On one hand, it boosted the Nikkei Index (Japan’s premier stock index), which is often used to indicate the overall health of the country’s economy. On the other hand, there was no significant increase in borrowing and investments, the main goal of this stratagem. The effects of this policy were successful in the short term but limited in the long term.
Why did it happen?
Many central banks raised their interest rates to face inflation caused by supply chain problems, the COVID-19 pandemic, and the Russia-Ukraine war. While Japan tried to resist this move, it saw a rapid decline of the Yen against the dollar, leading to increases in the price of food and fuel.
Japan’s Central Bank increased interest rates from -0.1% to between 0 and 0.1%. 7 of the 9 board members of BOJ were in favor of this move. The country’s economy has been recovering and has seen healthy inflation over the past few months. Moreover, earlier this year, Japan’s largest companies, in a deal with the country’s biggest labor union, Rengo, increased wages by around 5.28%, the highest in 33 years (The Guardian). This, along with the expectations of reaching the 2% target inflation, gave the BOJ the confidence needed to go ahead with the momentous move.
What is the expected effect of the policy change on the Japanese economy?
According to a Reuters survey, around 60% of Japanese firms are expecting interest rates to continue to increase and reach 0.25% by the end of the year. Many of them expressed an increased interest in front-load spending before borrowing costs rise. Additionally, more rises in interest rates could result in a repatriation of funds from Japanese investors and attract foreign investors as well.
BOJ is anticipating wages to continue to increase and hopes that it will lead to a surge in spending. However, the wage increase occurred only in large companies and not SMEs (Small and Medium Enterprises), which represent around 70% of the workforce. If other companies don’t follow along then Japan’s stubborn saving culture might persist as workers won’t be able to face higher prices without a higher income.
How does Japan’s decision affect the global market?
The world entered an era of no negative interest rates when Japan abandoned the NIRP. This means that zero and negative interest rates will be long forgotten unless BOJ reverses its decision.
Throughout economic cycles, bondholders should expect low and peak interest rates to be higher than what they’re acclimated to. Plus, as mentioned earlier, Japan might see a repatriation of funds if interest rates continue to increase. This can negatively affect other countries like the U.S. as Japan is a big investor in U.S. treasury bonds, thus a decline in the sales of these bonds not only impacts the U.S. economy but also the world market.
Conclusion:
Japan’s historic move to end its negative interest rate policy comes as an attempt to bolster the country’s economy. This, however, is dependent on various factors such as wage increases and meeting target inflation. The policy change is also expected to affect global markets. In case of a negative repercussion, will the Bank of Japan reverse its decision on the policy shift?
Sources:
Retrieved from the World Economic Forum https://www.weforum.org/agenda/2024/03/japan-ends-negative-interest-rates-economy-monetary-policy/
Reuters https://www.reuters.com/markets/asia/reuters-tankan-indicates-business-confidence-japanese-economy-is-improving-2024-03-20/
The Asahi Shimbun https://www.asahi.com/ajw/articles/15206671
The Guardian https://www.theguardian.com/world/2024/mar/19/bank-of-japan-raises-interest-rates-negative-scrapped-borrowing-costs