Japan’s interesting monetary stance as deflation fears grow

The perceived wisdom is that nominal interest rates have a lower zero bound. The Swedish central bank (the Ricksbank) has effectively been charging financial institutions to deposit money at the central bank since 2009. On 29 January 2016 the Central Bank of Japan also introduced a negative interest rate on deposits. The -0.1 per cent rate currently applies to a portion of the reserves held by financial institutions at the central bank. The move is another attempt to pump energy into a struggling economy.

As the chart shows, since the mid 1990s there have been protracted periods of Japanese price deflation. In January 2013 Japan introduced a 2 per cent CPI inflation target. This was accompanied by a massive expansion of its quantitative easing programme, principally through purchases of government bonds from investors. Following the monetary loosening, buoyed too by a loosening of fiscal policy, the rate of inflation rose. It reached 3.7 per cent in May 2014.

However, through 2015 the rate of inflation began to fall sharply, partly the result of falling commodity prices, especially oil. Now there appears to be an increasing fear at the Bank of Japan that deflation may be set to return. The introduction of a negative deposit rate is intended to prevent deflation. In particular by affecting expectations of inflation. The hope is to prevent a deflationary mindset becoming re-established.

The further loosening of monetary policy through a negative interest rate follows on the heels of an acceleration of quantitative easing last October. Back then, the Bank of Japan said that it would conduct Open Market Operations so that the monetary base would increase annually be ¥80 trillion. This was reaffirmed in its 29 January announcement. For an economy that has experienced four recessionary contractions since 2008 and with provisional estimates suggesting that it contracted by 0.4 per cent in the final quarter of 2015, it remains to be seen whether further monetary loosening might yet be called for.

Data

Consumer Price Index Statistics Bureau of Japan

Articles

Bank of Japan adopts negative interest rate policy CNBC, Nyshka Chandran (29/1/16)
Japan adopts negative interest rate in surprise move BBC News (29/1/16)
Bank of Japan shocks markets by adopting negative interest rates Guardian, Justin McCurry (29/1/16)
Japan stuns markets by slashing interests rates into negative territory Telegraph, Mehreen Khan (29/1/16)
Japan introduces negative interest rate to boost economy The Herald, (29/1/16)

Questions