Negative interest rates in Japan

Out of options and desperate for resurgence, the Japanese economy has been forced to try its luck with negative interest rates. The move was far from anticipated. Just eight days before the policy’s adoption, the Bank of Japan’s Governor, Haruhiko Kuroda, had said that such a plan was not under serious consideration. The shock value of the policy’s implementation could very well cement the deteriorated relationship between Japanese firms and the BOJ as repeated actions of this nature will only continue to validate market uncertainty for firms. Regardless, it is time to start asking the question of whether or not the Federal Reserve would consider such a policy here at home in the event of a recession.

Though the European Central Bank can be credited with first putting the negative rates theory into practice, the case in Japan is for more important as far as the U.S. is concerned because Japan is a sovereign state with its own currency. Although the Fed slightly increased interest rates this past December in an attempt to signal confidence in the American economy, rates are still very close to zero. Given the experimentation with the negative rates policy elsewhere in the world, it might not be unreasonable to see the Fed add negative interest rates to its monetary policy toolkit.

So what would the implications of a negative rates policy in the U.S. be? The case study in Japan provides us with a fair start at answering this question. The ultimate goal of the negative rates policy in Japan is to guide inflation to the golden 2 percent mark by encouraging lending in the hopes of stimulating economic growth. In theory, the logic would follow that, by essentially charging a fee to banks for holding their money at the central bank, there is greater incentive for banks to lend out the money. Interestingly enough, however, the BOJ only set negative rates on newly deposited funds. Thus, the nearly $2.5 trillion in excess reserves currently sitting at the BOJ can continue to sit there without penalty. Why would they do this? And would the Fed take a similar approach?

Well, the BOJ does not want to penalize banks so harshly that their profits fall and their propensity to lend is even further diminished. Applying the negative rate to funds already held at the BOJ might have incited banks to engage in protective behavior rather than stimulating action. But how will Japan ensure that new money is flowing through the country? Japan thinks its continuation of a quantitative easing program wherein it purchases 80 trillion yen worth of debt annually will pump more cash into the economy. Thus, there will not be a shortage of new money in the system, and the new money has a greater propensity to be lent than held when the QE and negative rates policies are combined. So the policy seems to, at the least, sound like a fair bet for defibrillating the Japanese economy. Many economists, however, are already certain that it will not work. But what about the U.S.? Could aggressive monetary policy measures be employed in a similar manner here in the states?

I wouldn’t be surprised if we saw the Fed give it a go during a future economic downturn. Low unemployment rates combined with deflation might make negative rates, in conjunction with the purchasing of bonds, a viable neoclassical tool for economic stimulation in the event of a recession. There is no question that anemic levels of inflation in the U.S. are a problem. The dramatic falls in oil prices, minimal growth in wages and rigid flatness in food and energy prices could validate the Fed’s use of an experimental mechanism such as negative rates. But again, it is still hard to say whether or not such a policy would actually be successful.

In Europe, negative rates have had mixed results. Analysts at Citi say that “no country that has gone into negative rates has experienced major shifts in its growth and inflation profile.” Surely, negative rates are a desperation move: a last resort tool used to encourage the movement of money away from the central bank, though not necessarily towards lending. Therein lies the major hiccup in the policy. In order to tackle this issue, banks need to better understand the shortcomings of the negative rates policy through process tracing. We should be asking important questions about the flaws in our logic and theory. Where does the empirical evidence not match up with our expectations? Where is the money that is no longer being parked at the central bank going? Are consumers saving that money in even higher proportions? Do banks need to start implementing negative interest rates on consumer savings in order to encourage us to spend more? Wow, you’d hate to see that! I took this a little too far, but my point is that we have identified a seemingly sound theory that needs empirical testing. The next step is to identify where this theory falls short when it is put into practice and what we can do to ameliorate its observed deficiencies.

So what can we conclude as of now? Not much. As American economists begin to closely monitor what happens with Japan, it is time to begin forecasting scenarios wherein the Fed slides rates down below 0 percent. Of course, the U.S. is not desperate enough to engage in such behavior quite yet, but there is no harm in studying the policy’s effects to prepare for the uncertainty of the future. It will be interesting to see if this policy actually changes lending practices in Japan when future data is released, and it is certainly no secret that the Fed will be contemplating the implications of this monetary policy tool should it ever need to be employed here at home. At the end of the day, however, the negatives rate policy could very well just be another swing and miss.

Ajay Desai is a Trinity freshman. His column usually runs on alternate Tuesdays.