From ZIRP to NIRP Part I: The Failure of Japan’s Plunging Interest Rates

Japan’s Lost Years and the Introduction of ZIRP

When the Japanese asset price bubble burst in 1991, what was then the world’s second largest economy entered into a period known as the Lost Years. In response to nearly a decade of economic stagnation and fears of a persistent deflationary spiral, the Bank of Japan (BOJ) introduced a zero interest rate policy (ZIRP) in February 1999. The rationale behind the desperate gambit was that the zero interest rates would encourage banks to lend money cheaply, spurring business activity, raising consumer prices, and kickstarting economic growth. In order to inject more liquidity into the market, the BOJ enacted quantitative easing measures in March 2001, buying back Japanese government securities. As a result, the benchmark interest rate on 10-year government bonds dropped to as low as 0.5% at one point.

The BOJ Doubles Down with NIRP in 2016

Instead of stirring from its anemic state, the Japanese economy has been essentially stuck in a 1% growth trajectory for nearly 25 years. As Yale economist Stephen Roach notes, real annual GDP growth fell even further to 0.6% in 2012, when Shinzo Abe became Prime Minister and ushered in “Abenomics.” Instead of acknowledging the failure of its monetary experiment, the BOJ has doubled down, adopting a negative interest rate policy (NIRP) in January 2016. Now, Japanese banks are charged 0.1% for entrusting their reserves to the central bank. Yields on 10-year government bonds dipped below zero shortly thereafter in February.

Moreover, the BOJ has bought up nearly one-third of outstanding Japanese government bonds to no discernible effect. “[Quantitative easing] is at the end of its limits. All you’re doing is building up excess reserves in the banking system,” Marvin Barth, global head of foreign-exchange strategy at Barclays said to CNBC.

Despite aggressive easing and NIRP, deflation has persisted, with core consumer prices falling another 0.5% in July 2016, according to the New York Times. Even with an abundance of extremely cheap money, businesses have refused to borrow more from banks. Rather than rising, the lending rate actually declined to 2.0% in March 2016, following the introduction of NIRP. Part of the issue seems to be that deflation leads to declining revenues, making even cheap loans difficult for businesses to repay. In effect, the BOJ has placed Japanese bankers in an untenable position, squeezed between a decline in lending income on one side and NIRP on the other.

Instead of sparking growth, the BOJ’s financial engineering has repressed the cost of capital, discouraged saving, and incentivized “reckless risk-taking” in an “income-constrained climate”, according to Roach. He warns that this is “treacherous terrain for economies desperately in need of productivity-enhancing investment”, reminding readers that a similar culture of recklessness helped bring about the 2008-2009 global recession.

References:

http://repository.upenn.edu/cgi/viewcontent.cgi?article=1001&context=od_theses_mp

http://www.nytimes.com/2016/09/21/business/international/japan-boj-negative-interest-rates.html

http://www.nber.org/chapters/c0092.pdf

https://www.project-syndicate.org/print/desperate-central-bankers-by-stephen-s–roach-2016-09

http://www.cnbc.com/2016/04/07/what-the-bank-of-japan-boj-will-do-now-that-negative-rates-have-disappointed.html

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