Japan's negative interest rates

Monetary policy is a key tool of economic management. It is usually applied by Central Banks to control inflation. The main tool of monetary policy is the rate of interest, although since 2008 the creation of additional money to add to the money supply (known as quantitative easing) has become common.

When interest rates are changed they affect the decisions of firms and households so that consumption and investment may change. Interest rate movements can also affect exchange rates. Therefore the policy can influence Aggregate Demand (AD).

The Japanese economy has seen many years of slow growth or recession. The chart below shows that Japan's relatively poor economic performance dates back to the 1990's, but the GFC has affected them like every other major economy.

The Japanese government has used expansionary fiscal (budgetary) policy and expansionary monetary policy since the 1990's. This has had little success in stimulating the Japanese economy.

The latest move has been to set negative interest rates. This applies to commercial bank deposits with the Bank of Japan. It means it costs the commercial banks money to have cash in their accounts at the Bank of Japan. Therefore, reason the Bank of Japan, it is more profitable for the commercial banks to lend the money to their customers and so stimulate AD.

Will it work? That seems unlikely given the failure of earlier stimulus measures which include a large quantity of money creation. However the fact that the Bank has tried to do something extra has encouraged the stock market.

The BBC cover the story here 

Questions.

1. Note the fall in the value of the Yen described in the article. Can you explain why the Yen depreciated?
2. What factors might cause an expansionary monetary policy be ineffective in raising AD?

This article has great relevance to IB students study of macroeconomic policy and exchange rates. For VCE the process of how monetary policy works and its influence on AD through consumption, investment and net exports, via exchange rates, is equally relevant.