Last Friday, Bank of Japan’s president, Haruhiko Kuroda, announced that the BOJ will institute negative interest policy to encourage banks to lend, in what I consider to be a desperate attempt to boost Japan’s economy. A negative interest rate will be applied to a “portion” of funds banks have on deposit at the BOJ. An interest rate of 0.01% will be applied to other holdings. The BOJ also announced that it will maintain its 80 trillion yen ($666 billion) a year in government-bond purchases.
Risk asset markets rallied on the news of more central bank (spiked) punch. However, I doubt that negative interest rates will do much, if anything, to meaningfully stimulate Japan’s economy. It is not the supply of credit which is Japan’s main problem. It is the demand for credit. It is true that Japan’s two-decade-long malaise was caused, in part, by poor credit supply.
Following Japan’s boom of the late 1980s, Japan’s banks were saddled with bad debt. Since there were little efforts by Japan’s policymakers to resolve banking system problems, these so-called zombie banks were unable or unwilling to lend as they had before. During the next two decades, Japanese consumers adapted to life without easy access to credit. The response by Japan’s policymakers was to continually lower interest rates. However, this did not do much to boost lending as Japan’s banks were still unwilling or unable to lend. Instead, Japan’s financial institutions simply borrowed on the short end and either used the cash to shore up balance sheets or used the proceeds to buy Japanese government bonds (JGBs). This helped to drive down long-dated JGB yields. The resulting lack of inflation from sluggish economic growth also aided in pushing long-term Japanese interest rates lower.
Yield of 10-year JGB since 1990 (source: Bloomberg):
Japan Annualized QoQ GDP since 1994 (source: Bloomberg):
Annual readings of quarter-over-quarter GDP are now the accepted measure of economic growth. Bloomberg data only goes as far back as 1994 for Japan. However, one can see that since 1994, annual Japan GDP has averaged 0.8%. It is little wonder that Japanese interest rates and bond yields have remained low for two decades.
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