MITSURU MISAWA

NEGATIVE INTEREST RATES: THE BANK OF

JAPAN EXPERIENCE

For more than 20 years, all efforts by the Japanese government and the Bank of Japan (BOJ) to
revitalize the nation’s economy failed to stop both its deflationary spiral and weak growth. To
address these twin issues, Japanese Prime Minister Shinzo Abe unveiled a new fiscal strategy,
known as “Abenomics,” after he took office in 2012. His initiative aimed to end Japan’s
economic stagnation, boost domestic demand, increase gross domestic product (GDP) growth,
and hold inflation at 2%.

Early in 2013, the central bank applied quantitative monetary easing (QE)1 by buying Japanese
government bonds (JGBs) with the aim of achieving an inflation target of 2% in two years. At
that time, the short-term prime interest rate sat at 1.475% per year.

Although the BOJ’s initial round of QE doubled its balance sheet in 2013, the question
remained as to whether the new policy would be able to drive Japan’s economy out of its
stagnation.

In 2014, the government increased Japan’s consumption tax from 5% to 8% to pay for social
welfare spending, and in response, consumers reduced their personal spending while markets
remained in turmoil. To relieve recessionary pressure, the central bank was forced to progress
to a second, open-ended phase of quantitative and qualitative easing (QQE) that committed to
annual asset purchases of JPY80tn (USD660bn), a strategy it hoped to continue until the 2%
target inflation rate was achieved.2 This too failed to achieve the desired results.

On 20 January 2016, Haruhiko Kuroda, the governor of the BOJ, and the central bank’s policy
board gathered in Tokyo, where they announced a radical plan—the introduction of QQE with
a negative interest rate—to achieve inflation of 2% in the shortest time.

1 “Introduction of Quantitative and Qualitative Monetary Easing with a Negative Interest Rate,” Bank of Japan, 3 February 2016,
https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf, accessed 20 November 2019.
2
“Expansion of the Quantitative and Qualitative Monetary Easing,” Bank of Japan, 31 October, 2014,
https://www.boj.or.jp/en/announcements/release_2014/k141031a.pdf, accessed 5 May 2020.

Professor Mitsuru Misawa prepared this case for class discussion. This case is not intended to show effective or ineffective handling
of decision or business processes. The authors might have disguised certain information to protect confidentiality. Cases are
written in the past tense, this is not meant to imply that all practices, organizations, people, places or fact mentioned in the case
no longer occur, exist or apply.

© 2020 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be digitized, photocopied
or otherwise reproduced, posted or transmitted in any form or by any means without the permission of The University of Hong
Kong.
Ref. 20/651C

Last edited: 15 June 2020

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 20/651C Negative Interest Rates: The Bank of Japan Experience

An experienced leader and former president of the Asian Development Bank, Kuroda was the
bank’s 31st governor. Kuroda’s academic background at both the University of Oxford and the
University of Tokyo had exposed him to Western fiscal policy. His bold strategy was unveiled
halfway through his first five-year tenure with the central bank.

Kuroda’s plan aimed to enhance lending and investment, and it also supported Abenomic
policies. The BOJ’s adoption of negative interest rates followed that of a handful of other
central banks, which included the European Central Bank (ECB), and those of Denmark,
Sweden, and Switzerland, that also implemented negative interest rates. Could Kuroda’s policy
gamble achieve its goal and hold inflation? What happened if it failed?

A Radical Step

Almost the entire rich world is stuck in a zero-interest-rate liquidity trap

situation, and I think everybody is haunted by the possibility that there’s no
way out of it. If Japan shows a way out of that, it will be very encouraging.
- Greg Ip, Wall Street Journal3

After Kuroda’s announcement, the BOJ pursued monetary easing in three significant
dimensions of the economy: interest rates, quantitative monetary policy, and qualitative
monetary policies.4

As the central bank controlled Japan’s money supply, the conventional way to stimulate the
economy was to buy and sell government debt in small quantities as short-term Japanese
government bonds (JGBs). When the BOJ acquired JGBs in large amounts, the move was
regarded as an unconventional policy. It was termed unconventional because by Japanese law,
the BOJ was not allowed to purchase newly issued short-term government securities5 as this
was defined as “self-financing.” The BOJ’s purchase of short-term government securities was
legal only for a limited amount of purchases under extreme circumstances. It was regarded as
unconventional because it was undertaken in order to increase the money supply to the markets,
which in this case was the aim of the central bank’s move.

The bank also purchased longer-maturity government bonds, exchange-traded funds (ETFs),
and Japan real estate investment trusts (J-REITs) to increase the money supply. These
securities were qualitatively different, and this monetary policy formed the basis of qualitative
easing.

The BOJ believed both monetary policies—quantitative and qualitative—needed to work

together to create monetary easing.

Negative Territory
On 16 February 2016, a negative interest rate of –0.1% was added to all current accounts that
financial institutions held with the central bank. Financial institutions that deposited money
with the BOJ after this date lost money. This BOJ strategy encouraged financial institutions to
lend their excess liquidity to industry rather than stash it away as a deposit.
3 J. McBride, and B. Xu, “Abenomics and the Japanese Economy,” Council on Foreign Relations, 15 February 2016,
https://www.cfr.org/backgrounder/abenomics-and-japanese-economy, accessed 3 March 2020.
4 H. Kuroda, “Answers to Frequently Asked Questions on Quantitative and Qualitative Monetary Easing, (QQE) with Negative

Interest Rates,” 7 March 2016, https://www.boj.or.jp/en/announcements/press/koen_2016/ko160307a.htm, accessed 2 March

2020.
5 Bank of Japan Act, Law number: Act No. 67 of 1942, Japan,

http://www.japaneselawtranslation.go.jp/law/detail_main?re=&vm=02&id=92, accessed 28 November 2019.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

In reality, with each current account that financial institutions held in the central bank, the BOJ
created three tiers of interest, so that their deposit was then divided into three sections. The first
tranche was paid interest (positive), the second was charged at the –0.1% negative interest rate,
and the last third received zero interest rates. This method ensured that the implementation of
negative interest rates did not substantially reduce the earnings of financial institutions and
undermine their functions as financial intermediaries.

For example, if a financial institution deposited a hypothetical JPY90mn with the BOJ, the BOJ
paid 0.1% interest on the first part of that deposit, JYP30mn. For the second tier, the central
bank deducted 0.1% interest, and for the third tier of JYP30mn, the BOJ paid no interest.

Academically, a negative interest rate policy was an unusual monetary policy tool where
nominal target interest rates were set with a negative value, below the theoretical lower bound
of 0%.6 In a practical sense, in adverse situations, depositors paid interest to banks.

Negative interest rates were used when increased spending and investment were needed. The
policy was regarded as unorthodox, since those who held deposits were encouraged to spend
rather than hold cash in banks where it incurred a guaranteed loss.7 In effect, central banks
pernalized financial institutions for holding cash, in the hope that these penalties prompted
institutions to increase lending.8 In Japan’s case, the central bank used negative rates in an
attempt to boost economic growth because other incentives failed.

Abenomics in Action
As a direct result of Abenomics, Japan’s economy exhibited signs of moderate recovery.9 In
the third quarter of 2016, Japan’s growth accelerated. GDP increased by 2.2% in annualized
terms, in the three months through to September. This move was significant because GDP had
grown at less than 1% for the past two decades. But the nation’s inflation rate remained at 1%,
lower than the targeted rate of 2%, and deflation continued.

Inflation gradually increased, and income to spending rose across both household and corporate
sectors. However, global risks continued.

Volatility in the global financial markets, caused by a fall in crude oil prices, and uncertainty
surrounded emerging markets and commodity-export-led economies, especially that of China,
eroded corporate confidence that Japan’s economic recovery plan would work. Kuroda knew
that if this happened, it undermined the positive inflation trends that had started to emerge.

To prevent this risk, and to ensure the price stability target of 2% was achieved, Kuroda’s
previous QQE strategy with a negative interest rate aimed to reduce the short end of the yield
curve. In order to do this, negative interest rates applied to deposits held in current accounts
caused a downward pressure on the interest rates across the full yield curve. The bank also
increased the purchases of JGBs.

Kuroda hoped that combining QQE with a negative interest rate policy would help the bank
gain more control of money market operations. Another key objective was to increase the BOJ’s

6 B. Beers and G. Scott, “Negative Interest Rates Definition,” Investopedia, 29 January 2020,
https://www.investopedia.com/terms/n/negative-interest-rate.asp, accessed 3 March 2020.
7
Ibid.
8
“How does a negative policy rate work?,” Japan Times, 14 August 2019,
https://www.japantimes.co.jp/news/2019/08/14/business/negative-rate-policy-work/#.XiPCARMzZjs, accessed 3 March 2020.
9 J. Soble, “Why Japan’s Economy Posted Surprisingly Strong Growth,” New York Times, 13 November 2016,

https://www.nytimes.com/2016/11/15/business/japan-economy-growth-trade.html, accessed 28 February 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

monetary base by at least JPY80tn (USD678bn) through the purchase of JGBs per year.10 In
2016 when QQE with a negative interest rate was introduced, the outstanding balance of JGBs
held by the BOJ was JPY400tn, or 40% of the total outstanding JGBs issued. In April 2013
when the QQE monetary policy was adopted by the BOJ, the outstanding balance was JPY130tn.

With the overall aim of reduced interest rates across the full yield curve, the BOJ operated a
flexible purchase process that was aligned with financial market conditions. The remaining
maturity of JGBs purchased by the government averaged between 7 and 12 years. The BOJ also
purchased ETFs and J-REITs, at an annual rate of approximately JPY3tn and USD90bn,
respectively. It also purchased commercial papers (an unsecured form of promissory notes) and
corporate bonds at an annual rate of approximately JPY2.2tn and JPY3.2tn, respectively.

Unchartered Waters
Although QE doubled the BOJ’s balance sheet in 2013, inflation stagnated below 1%. The
central bank then progressed to a second, open-ended phase of QQE that consisted of JYP80tn
(USD678bn) in annual asset purchases.11 In September 2014, total assets outstanding on the
BOJ’s balance sheet were JPY278tn (USD2.36tn). By March 2016, this increased by 46% to
JPY406tn (USD3.44tn).12

The scale of the central bank’s purchases had never previously been observed. The BOJ assets
equated to 70% of the nation’s GDP, 45% higher than the US Federal Reserve and ECB assets,
which were 25% of their respective GDPs [see Exhibit 1].

The European Experience

Although similar measures were introduced in Denmark, Switzerland, and Sweden between
2012 and 2015, the ECB was the first major European central bank to introduce negative
interest rates in June 2014.13

Negative interest rates helped to encourage the extension of European bank loans, but it was
not certain that similar results would be achieved in Japan, where commercial bank loans were
relatively solid. Still, Kuroda believed his policy would lead to increased prices, consumption,
and capital expenditure. How negative interest rates would affect Japan was unknown at the
time of their introduction, as adverse side effects were known only in the European context.
Although European central banks adopted negative interest rates, economists did not agree on
the extent to which these succeeded.

Negative interest rates affected a nation’s economy in two key areas: they reduced interest rates
on loans, which in theory boosted capital and housing investment. They also encouraged a
process by which money was transferred from low-yield government bonds to foreign securities.
In theory, negative interest rates weakened the Japanese currency and elevated stocks.

In Europe, their introduction caused a sharp decline in bank lending rates and increased bank
lending. However, this was modest at best, since a slowdown in economic activity directly
impacted the demand for loans, which decreased by 3% on an annual basis. This trend continued

10 “Financial statements,” Bank of Japan, https://www.boj.or.jp/about/account/index.htm/, accessed 5 May 2020.

11
Ibid
12
Ibid.
13 “How does negative rate policy work,” Japan Times, 14 August 2019,

https://www.japantimes.co.jp/news/2019/08/14/business/negative-rate-policy-work/#.XiPCARMzZjs, accessed 25 February

2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

for one year. Additionally, European banks were reluctant to offer high-risk loans, as the low
rates they entailed meant they lacked sufficient incentives to enter into risky contracts.

Even where loan growth entered a positive cycle, there was only so much that the demand
achieved. Before the slump in crude oil prices, inflation hovered around 0%, and the projected
rates remained low in most European countries.

Central bank policies in Europe adversely affected households, especially retirees. In

Switzerland, Denmark, and Sweden, people increased their savings in response to rate cuts.
They feared low interest rates reduced their retirement savings. There was also an inherent risk
that these fears would spread through lack of demand, increased prices, and ultimately,
deflation. This was contradictory to the objectives of the central banks involved.

The European experience with negative interest rates was considered to be more serious than
Japan’s, because Japan’s percentage of retirees (age 65 and over) was the highest in the world,
at 27.58%, at that time. In Germany, that percentage was 21.46% of citizens, France (20.03%),
and the US (15.81%), respectively.14 Most of those in Japan were recipients of pension funds.
Since these incomes were fixed, they tended to save money if the future was uncertain.

Another risk was the effect negative interest rates had on currency markets. A year after the
ECB went negative, the euro fell by 18% against the US dollar in one year,15 because investors
shifted investments from the euro to USD treasury bonds, alternative currencies, and assets.

But a drop in the value of the euro enhanced the profitability of European companies and
boosted stock prices by 10%, year-on-year. Many economists speculated that the BOJ’s real
objective was to weaken Japan’s currency.16

In fact, the BOJ’s decision initially caused the JYP to fall and stock prices to rise, but the move
was short-lived. Uncertainty about the Chinese and US economies led to a further bout of
market turmoil.

Key Differences
Some inherent differences between Japanese and European economies were also of significance.

Although Japan’s financial system was stronger than Europe’s, Japanese companies and
consumers were extremely cautious after two decades of economic decline. Even if interest
rates fell further, demand for funds did not increase.

According to Kuroda, the QQE strategy, combined with negative interest rates, represented “the
most powerful monetary policy framework in the history of modern central banking.”17 When
the central bank adopted this strategy, the BOJ’s governor showed he was prepared to take
aggressive measures if they were needed.

14
“Global Aging Rate (Elderly Population Ratio) Changes by Country, 1990-2018,” Global Note,
https://www.globalnote.jp/post-3770.html, accessed 7 May 2020.
15 The US Dollar/ Euro Exchange Rate was 1.3690 in June 2014 and 1.1188 in June 2015. Bloomberg Currency Converter,

https://www.bloomberg.com/markets/currencies, accessed 28 February 2020.

16
A. Ross, M. Mackenzie, and J. Soble, “Abenomics Propels Yen Weakness,” Financial Times, 11 May 2013,
https://www.ft.com/content/dbdc8d5c-b8d9-11e2-869f-00144feabdc0, accessed 28 February 2020.
17 “Meeting with the Governor,” Bank of Japan, 1 February 2016,

https://www.boj.or.jp/announcements/press/kaiken_2016/kk1602a.pdf, accessed 20 November 2019.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

Kuroda’s Strategy
The degree of negative rates introduced by European central banks is bigger
than Japan. Technically there definitely is room for a further cut in Japan.
- Haruhiko Kuroda18

At first, markets questioned the ability of lenders to manage such a radical strategy.

Aware that some of the central banks in Europe had ventured near to, or even beyond, 0.1%,
Kuroda argued that Japan had “sufficient room for further monetary easing in the negative
interest rate dimension.”19

The prospect that interest rates could drop below zero rocked the bond market. Negative yields
for newly issued 10-year JGBs were observed for the first time. Investors sold off bank shares.
They feared rates that fell below zero had negative ramifications;20 since banks had a significant
role in support of Japan’s economy, any concerns about their viability reduced investors’
willingness to enter into risky propositions.

The Nikkei 225 Index (Nikkei Stock Average) fell by 24.1%—a move that started the day
before the new policy was implemented on 28 January 2016. On average, the Nikkei declined
by 7.8% between that date and 11 February 2016.21

The negative interest rate affected banks either directly through a bank’s BOJ accounts where
the impact was relatively minor, as the rate was only narrowly applied due to the tiered nature
of the application, or via the yield curve.

The BOJ’s policy exerted a strong downward pressure on the entire yield curve, a move that
flattened corporate lending margins and reduced financial institutions’ revenues. This had a
negative impact on lending and the smooth operation of the financial system.

Kuroda’s strategy was also viewed positively, since it was obvious that the central bank paid
higher prices for the JGBs it purchased from financial institutions, which proved positive for
sellers. The money that the BOJ exchanged for JGBs went into the sellers’ current accounts,
where it had the potential to earn a negative return.

To ensure financial institutions were willing to sell, prices at which the JGBs traded needed to
reflect the added cost of a negative interest rate. In addition, the reduction in the long-term
interest rates also increased bond purchase prices.

But from a financial institution’s perspective, any positive impact that the negative interest rate
of 0.1% yielded was outweighed by its negative impact.

18 “Bank of Japan Governor Haruhiko Kuroda Says He Won't Rule Out Deepening Negative Rates: Report,” Reuters, 21 August
2016, https://www.cnbc.com/2016/08/21/bank-of-japan-governor-haruhiko-kuroda-says-he-wont-rule-out-deepening-
negative-rates-report.html, accessed February 29, 2020.
19 T. Goto and K. Takami, “What Europe’s experience tells us about the BOJ’s experiment,” Nikkei Asian Review, 8 February

2016, https://asia.nikkei.com/Politics-Economy/Economy/What-Europe-s-experience-tells-us-about-the-BOJ-s-experiment,
accessed 29 February 2020.
20
I. Shimizu, “Markets weigh pros, cons of joining the minus 1% club,” Nikkei Asian Review, 11 February 2016,
https://asia.nikkei.com/Business/Finance/Markets-weigh-pros-cons-of-joining-the-minus-1-club, accessed 21 November 2019.
21
Ibid.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

Hitting Turbulence
After the BOJ announced its QQE policy, investors exhibited more risk-adverse behavior. In
the presence of higher risk, they engaged in safer investments, one of which was the Japanese
yen (JPY). In this regard, Abenomics achieved Prime Minister Abe’s objective to reduce the
value of the JPY, which normally traded at 110 to 115 to the USD, which then traded strongly
around JPY110.

Speaking before Congress, US Federal Reserve chair Janet Yellen indicated that US interest
rates would not be ramped up in the foreseeable future. But on December 2015, for the first
time in nearly a decade, the Fed increased its policy rate, which was near zero. Its decision not
to introduce further rate hikes narrowed the gap between the US and Japanese real interest rates,
allowing the JPY to gain ground on the USD.

There was an inherent risk that even a slight move into negative territory could have far-
reaching consequences. Immediately after the QQE policy was announced, bank stocks fell.
Investors were concerned that negative interest rates diminished lenders’ earnings. While the
policy was designed to reduce lending rates, there was little chance that the deposit rates would
also fall because they already bordered on zero. As such, there was a high risk that Kuroda’s
plan seriously undermined bank profits, which resulted in even less lending.

Controlling the Curve

In order to achieve the price stability target of 2%, it is necessary to drastically
convert the deflationary mindset among people and raise inflation expectations.
- Haruhiko Kuroda22

For a negative interest rate policy to succeed, Kuroda realized he needed to do more. He decided
that the BOJ needed to control the yield curve in order to meet the Abenomics inflation target
of 2% and maintain yields on 10-year JGBs, which acted as the foundation of long-term interest
rates, at around zero [see Exhibit 2].

In defense of his decision, Kuroda stated, “We have found through our bond purchasing and
negative rate policy that the yield curve can be controlled. Deciding the right interest rate level
is what central banks have always done. It is not that different.”23

According to conventional monetary theory, it was not possible to maintain yields in this
manner because long-term interest rates were not entirely within the control of a central bank.
But the BOJ took financial engineering to a new level when it introduced yield curve control in
an effort to boost Japan’s economy.24

Other factors, such as fiscal policy, external market conditions, and inflation expectations, all
influenced long-term interest rates. Monetary authorities traditionally focused on the factors
they controlled, namely short-term interest rates, to stimulate or dampen the economy. It was
assumed that to reduce or increase rates at the short end of the yield curve would also impact
long-term rates.

22
H. Kuroda, “Overcoming deflation: Theory and Practice,” Speech given by the Governor of the Bank of Japan, 20 June 2016,
https://www.bis.org/review/r160623a.pdf, accessed 7 May 2020.
23
S. Tani, “The Bank of Japan tries to bend the yield curve,” Nikkei Asian Review, 29 September 2016,
https://asia.nikkei.com/Economy/The-Bank-of-Japan-tries-to-bend-the-yield-curve, accessed 21 November 2019.
24 J. Cox, “CNBC explains: The Bank of Japan’s ‘yield curve control’,” CNBC, 21 September 2016,

https://www.cnbc.com/2016/09/21/cnbc-explains-the-bank-of-japan-yield-curve-control.html, accessed February 28, 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

While global central banks attempted to reduce long-term interest rates by purchasing
government bonds over a longer duration, maintaining their rates at a set level around zero was
something entirely different.

Although the bank increased the value of its monetary base by JPY80tn annually, this had
predominantly depended on the purchase of JGBs, and these were about to run out. In a
statement that tacitly acknowledged these technical limitations, Kuroda revealed that the new
framework raised “the sustainability of our monetary easing policy.”

Inflation Overshooting Commitment

A new inflation overshooting commitment was designed to maintain inflation at a steady rate.
However, no positive result was observed [see Exhibit 3].

An overshooting commitment could, theoretically, lead to actual inflation because the current
inflation rate was well below 2%. In August 2016, Japan’s year-on-year consumer price index
(CPI), which excluded fresh food, declined for the sixth consecutive month.

Although it was too early to look beyond a 2% target, the BOJ’s solution was to expand its
monetary base, based on the observed CPI inflation rate instead of expected inflation.25

The central bank declared it would maintain its easing program as long as needed to achieve
and maintain an inflation target of 2% in a stable manner. Although the CPI varied according
to cyclical economic fluctuations, movements in the prices of international commodities, and
other factors, the central bank said it would not adjust its easing policy, even if the CPI exhibited
temporary growth beyond 2%. Inflation needed to reach 2% and remain there for a sustained
period before the BOJ considered ending the QQE program. Economists perceived this
overshooting commitment to indicate that the BOJ had learned from its previous mistakes.

To achieve 2% inflation, companies needed to give employees wage increases. Employees only
perceived a 2% price increase to be natural if their wages also increased by 2% annually.

But to fund higher wages, companies needed to be confident about Japan’s future growth.
Unfortunately, they lacked confidence, and their low expectations of economic growth stressed
the need for structural reform. However, the BOJ alone could not address this issue. This was,
perhaps, one of the most significant lessons of the QQE with the negative interest rate policy.

The Limits of Central Banking

Problems with monetary policy were not confined to Japan. In August 2016, US Federal
Reserve chair Janet Yellen mentioned that fiscal policies and structural reforms could play an
important role in enhancing the strength of the economy.26 Her European counterpart, Mario
Draghi, president of the ECB, had previously stressed that monetary policy alone was not
sufficient to achieve balanced growth.27

25 H. Kuroda, “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control: New Monetary Policy
Framework for Overcoming Low Inflation,” Bank of Japan, 8 October 2016,
https://www.boj.or.jp/en/announcements/press/koen_2016/ko161009a.html, accessed 3 March 2020.
26
J. L. Yellen, “The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future,” Federal Reserve, 26 August 2016,
https://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm, accessed 1 March 2020.
27 M. Draghi, “Monetary policy and structural reforms in the euro area,” European Central Bank, 14 December 2015,

https://www.ecb.europa.eu/press/key/date/2015/html/sp151214.en.html, accessed 1 March 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

Kuroda agreed. 28 He said, “The BOJ believes that its monetary policy and the government’s
fiscal policy, as well as initiatives for strengthening Japan’s growth potential, would navigate
Japan’s economy toward overcoming deflation and achieving sustainable growth.” 29 The
question remained as to whether its policy framework would help the BOJ achieve its 2%
inflation target, and whether this was a viable monetary policy tool for central banks.

His strategy was inherently risky, and the credibility of the BOJ stood to be damaged if it was
forced to depend on increasingly complicated monetary policies to ensure its actions benefited
Japan’s economy.

By September 2016, the US Fed and the BOJ had adopted very different positions. The BOJ
struggled to ease monetary policy, while the Fed struggled to reduce monetary accommodation.
Although their strategies differed, both central banks agreed that monetary policy alone could
not be used to address complicated economic scenarios.

The US Fed’s decision to leave interest rates on hold was simpler than the BOJ’s interventionist
policy. The Fed waited for evidence that the labor market and the US economy were sufficiently
robust before it influenced interest rates. It wanted to be sure that the US economy weathered
uncertainties elsewhere, particularly in Europe and China. On face value, the Fed saw positive
signs. Participation rates rose and consumer spending increased slowly. However, warning
signs, in the form of capital investment trends and a major inventory correction, significantly
reduced domestic growth. If the inventory problem was resolved, there was a chance capital
spending could be revived. If US President Donald Trump’s administration embraced higher
investment spending, higher interest rates would occur.

In December 2016, the world’s central banks doubted that they had the tools to boost the real
economy and deliver inflation targets. Unlike the US, the BOJ didn’t have to contend with the
politics that surrounded the US Fed. But its job was no easier. In September 2016, the BOJ
announced two new policies. It wanted inflation not just to meet its 2% target, but to overshoot
it. To do this it targeted short-term interest rates and long-term government bond yields.30

Would Abenomics Reinvigorate Japan’s Economy?

The BOJ aimed to expand its monetary base until inflation exceeded the 2% target and remained
at that level for a prolonged period. It announced that it would achieve a 0% yield on 10-year
JGBs while it invested JYP80tn (USD678bn) in bonds, every year. This move was designed to
demonstrate that the central bank intended to hit its inflation target. Such a commitment looked
somewhat optimistic given that the monetary base had increased by 300% since Abenomics
emerged in December 2012.

There was also a lack of clarity about the BOJ’s actual target. The central bank effectively
adopted a price target for 10-year JGBs at zero yield, because bond price and yield were
inversely related.

Although the bank set a quantity target, to purchase JPY80tn of bonds a year, the price or yield
still varied. Therefore, one of its targets needed to be relinquished because it was not possible
to simultaneously focus on price and quantity.

28 “New Framework for Strengthening Monetary Easing: Quantitative and Qualitative Monetary Easing with Yield Curve
Control,” Bank of Japan, 21 September 2016, https://www.boj.or.jp/en/announcements/release_2016/k160921a.pdf, accessed
20 November 2019.
29
M. Misawa, “Sales Tax Increase in 2014 Under Abenomics: The Japanese Government's Dilemma,” 2016, The University of
Hong Kong, Ref. 15/563C, http://www.acrc.org.hk/, accessed 20 November 2019.
30 G. Ip, “Central Bank Tools Are Losing Their Edge,” Wall Street Journal, 21 September 2016,
https://www.wsj.com/articles/central-bank-tools-are-losing-their-edge-1474501934, accessed 1 March 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

In reality, the BOJ had six targets:

 A price target for JGBs

 A quantity target for JGBs
 Negative interest rates at –0.1%
 Use of the JPY as a transmission mechanism to inflation
 2% or more inflation
 A steeper yield curve (or higher interest rates for longer-dated bonds)

The steeper yield curve was derived from efforts to maintain 10-year yields at zero while
longer-dated JGB yields increased. This enhanced the profitability of the banks and helped
insurance firms that were struggling in the negative rate environment because both invested in
JGBs. If longer-dated JGB yields increased, their returns on the investments improved.

Unless the central bank or Japan’s government engineered a sustained GDP increase and higher
inflation, investors continued to buy longer-term bonds and, contrary to the BOJ’s objectives,
this flattened the yield curve.

The US Fed and the BOJ did, however, have something in common. Both failed to stimulate
the type of inflation that was required to back away from overtly easy monetary accommodation.
All central banks shared the same issue.

To some extent, monetary accommodation made issues much worse for central banks. People
had no choice but to save when they were concerned that the value of their money had
diminished. Those who did not have significant pensions were motivated to save more to cover
their retirement. Operating in isolation, central banks were not able to deliver the solid
economic changes needed to turn the situation around.

Abenomics was not groundbreaking. Since Japan’s real estate bubble burst in the late 1980s,
the government had implemented programs designed to secure near-zero interest rates. It
invested billions of yen in its efforts to improve the economy and had subsequently accumulated
one of the world’s highest public debts.

Shinzo Abe believed Abenomics would break this cycle, reduce exchange rates, and give the
export trade market a much-needed boost. As he had anticipated, the JPY did initially fall
against the US dollar, by as much as 50% at one point. But this failed to increase exports, and
the stock market remained volatile.

A weaker JPY was not necessarily positive, as it drove up import prices and reduced consumer
demand and spending. Global oil prices reached record lows, down from more than USD100 a
barrel to USD30 a barrel between 2014 and 2016. This only added to Japan’s deflation problem.
Eventually, a combination of cheap oil and a stagnant world economy reduced any chance that
Japan’s economy could recover from its deflationary spiral.

Critics of Abenomics pointed out that the policy enhanced risk, without any benefit. They
believed monetary easing spurred hyperinflation or did little to reverse a systematic deflationary
mindset. Japan’s national debt, which reached more than USD11tn, represented more than
245% of the country’s GDP [see Exhibit 3].

The International Monetary Fund (IMF) warned Japan that its debt levels could not be sustained
and that structural reforms were needed: “Without additional reforms, Japan risks falling back
into lower growth and deflation, a further deterioration in the fiscal situation, and an

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 20/651C Negative Interest Rates: The Bank of Japan Experience

overreliance on monetary stimulus with negative consequences for the region.”31 To reduce the
deficit, Prime Minister Abe increased Japan’s taxes, a move that undermined the objectives of
the program.32

The national consumption tax that increased from 5% to 8% in 2014 further reduced consumer
spending and was blamed for a renewed recession.33 A planned increase to 10% was postponed
as a result of the 2014 performance.34 Although this decision aimed to encourage growth, it
potentially went against the fiscal sustainability goal.

Negative interest rates unsettled global economists. Kuroda accepted that there was every
chance his policy could damage the banking system and cause Japan’s citizens to hoard cash at
home, which added to deflation.

Decision Time
Nine months after Kuroda made his announcement that the BOJ would adopt QQE with
negative interest rates in January 2016, the BOJ reviewed its plan and changed direction, from
a focus on the quantity of the monetary base to a renewed emphasis on interest rates.

Just when the BOJ would achieve a 2% inflation target remained a key question. Its purchases
of JGBs had reached double the volume of the new debt issued by the government. However,
this was not enough to stop a rapid reduction in consumer prices. In 2016, prices fell at the
fastest rate since the introduction of QE in 2013.

The BOJ’s unconventional policies and tools appeared to have failed. When the central bank
hit the zero lower bound—in theory, the lower limit of interest rates is zero—it found itself with
no room to reduce nominal short-term interest rates, so it engaged in aggressive government
bond purchases, a move that reduced rates across all periods.

As purchases neared their limit, the bank implemented a negative interest rate policy. This
strategy was considered by the market to be unthinkable, because it undercut the bank’s asset
purchasing program. But this time, the BOJ leveraged a head-on challenge to monetary theory.
In light of the bank’s unsuccessful track record, markets were uneasy and speculation was rife
that even more unconventional measures would emerge [see Exhibit 3].

Kuroda now had to deal with a number of serious dilemmas.

1. BOJ control of long-term rates

Although the 2% inflationary target had been set more than three years earlier, it had not been
achieved, and at the same time, the amount of Japanese bonds the BOJ purchased neared its
limit. The bank realized it needed to aim for its inflation target over a longer period of time.
Setting this at 0% could be achieved without the bank buying as many government bonds.

31 “Asia and Pacific: Sustaining the Momentum: Vigilance and Reforms,” IMF Regional Economic Outlook, April 2014,
https://www.imf.org/en/Publications/REO/APAC/Issues/2017/02/23/Sustaining-the-Momentum-Vigilance-and-Reforms,
accessed 20 November 2019.
32 S. Tani, “The Bank of Japan tries to bend the yield curve,” Nikkei Asian Review, 29 September 2016,

https://asia.nikkei.com/Economy/The-Bank-of-Japan-tries-to-bend-the-yield-curve, accessed 21 November 2019.

33 Ibid.
34
Ibid.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

The long stagnation of the real economy caused a shift in the portfolios of commercial banks
from lenders to JGBs. The portfolio shift was caused by a fall in the ratio of the loan rate to unit
lending costs, or the bank’s price-cost margin for lending.35

Abenomics required that banks lend more money to industries and consumers increase
investment and consumption to stimulate growth. The government did not welcome the banks’
shift from loans to JGBs. As long as the BOJ bought JGBs, banks bought and held more JGBs.
This created a dilemma for the BOJ. Could the BOJ continue along this path?

2. The BOJ recognized that quantitative expansion was limited but was still a
viable method to ease interest rates. Could this approach be successful?
Although there seemed reasonable scope to implement negative rates in Europe, this was not
the case in Japan. It was feasible to cut rates to –1%, but because the profit margins of Japanese
financial institutions were smaller than their European counterparts, adverse effects on bank
earnings were more pronounced. The matter could not be resolved via the same strategy used
in Europe.

3. The BOJ adopted a forward guidance policy to expand the monetary base until
it reached its 2% target. Could this be sustained?
To raise inflationary expectations, the bank adopted a forward guidance policy, and adjusted
the 2% inflation target to an inflationary goal of over 2%. Without an increase in the money
supply, the policy lacked creditability and was not sustainable over the long term. Even if the
policy was successful, problems managing long-term interest rates might have emerged when
inflation breached 2%; as such, the policy was also not sustainable.

4. If the BOJ improved the sustainability of its monetary policy, could it continue
to contribute to economic policy?
If the BOJ implemented a policy that successfully addressed deflation and economic stagnation,
it would continue to play an important role in economic policy. However, because of the
protracted nature of the problem and the policy’s failure to bring about inflation, options
narrowed for the central bank. This limited its future role.

5. What if further interest rate reductions failed to stimulate the economy?

The belief that lowering rates beyond zero into negative territory would stimulate the economy
was inaccurate. The impact on bank earnings impaired the ability of financial institutions to
lend to the real economy, and damaged the money creation aspect of fractional banking, a key
element of credit creation in developed economies. There was also a negative impact on
insurance and pension asset management. Falling interest rates also made workers risk adverse.

6. With limited options for easing, should the BOJ work with government?
With little room for easing, the BOJ needed to work with the government’s fiscal policy.
Options included the use of so-called helicopter money or, at the very least, the application of
a supportive monetary policy in conjunction with government fiscal policy. The central bank
could also use its influence to press for supply-side reform, the missing element in Prime
Minister Abe’s economic policy.

35 K. Ogawa and K. Imai, “Why do commercial banks hold government bonds? The case of Japan,” Journal of the Japanese and
International Economies 34 (2014): 201–216, https://www.sciencedirect.com/science/article/pii/S0889158314000471, accessed
1 March 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

7. How did helicopter money work?

Helicopter money, in the form of long-term bonds issued by the government, was accompanied
by a commitment from the BOJ to hold bonds for a protracted period. The government could
even issue perpetual bonds, i.e., completely nonredeemable bonds, directly to the central bank.
This meant the government printed money. However, such a move risked hyperinflation and a
volatile devaluation of the currency in the future.

The BOJ’s QQE could target other asset purchases, such as municipal bonds, or the debt of
state-backed companies where intervention would have more impact, or the deep and liquid
treasury bond market (which bought JPY80tn of JGBs each year). Compared to this market, the
municipal bond market was characterized by low volume and illiquidity, giving the BOJ a
greater chance to distort it. Pumped prime, these markets introduced an upward price bias, and
as the bank continued its purchases at inflated rates, this was a close approximation of helicopter
money.

The final option was a special BOJ account that the government would always have the ability
to borrow from by committing to purchase a large portion of government debt or buying
corporate bonds. This also represented a form of helicopter money.

Owing to the risk of future high inflation as a result of creating a money supply that allowed
the government to implement its fiscal policy, the BOJ refrained from supporting a helicopter
money policy.

8. What if the BOJ purchased perpetual or foreign bonds?

Issuing zero-coupon bonds or replacing bonds held by the bank with nonredeemable perpetual
bonds offered a cost-free form of financing for the government and, if the bonds were parked
on the central bank’s balance sheet, increased its ability to stimulate the economy with fiscal
policy.

The large-scale purchase of foreign bonds was another alternative, which would exert a
downward pressure on the JPY, an outcome Prime Minister Abe desired because it would
stimulate Japanese exports.

Both policies faced legal hurdles. Perpetual bonds fell foul of Article 5 of the Public Finance
Law of Japan, which forbid the central bank from underwriting public debt. In addition, the
Bank of Japan Act outlawed the purchase of foreign bonds as a means of currency intervention.
But there was some room to maneuver with perpetual bonds. If the amount was limited by the
Diet and only used for the purchase of foreign bonds, it could be carried out under the guise of
monetary policy.

In 2016, faced with intractable deflation and perpetual economic stagnation, Haruhiko Kuroda
admitted that monetary policy had reached the limits of its effectiveness.

This led to greater cooperation with the government in order to lend greater traction to reflation
policies. Kuroda thought small tweaks to the framework would satisfy the market’s desire for
action, but there was no easy solution. He felt that it was be better to recognize the limitations
of monetary policy when attempting to stimulate an economy entrenched in a deep malaise,
rather than attempt ever more unconventional forms of monetary stimulus.

The conclusion Kuroda reached was that it was reasonable to expect the BOJ to maintain
inflation close to target in normal economic circumstances, but given the depth of Japan’s
problem, monetary policy alone could not be expected to solve a deep-seated problem.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

Fears of Recession
Kuroda’s term was due to end April 2018, and although it looked as though he would leave
office before he achieved his primary goal, in a vote of confidence, he was reappointed by
Japan’s government for a second five-year term.

Despite the BOJ’s efforts to work with government, the nation had moved toward recession by
early 2020. When the consumption tax was eventually raised to 10% in 2019, it sparked the
biggest quarterly contraction since 2014,36 as households reacted against the dual effects of
minor wage gains and budgetary pressures. Although the move was unpopular, it fulfilled the
government’s dual needs: to pay for pensions and health care for Japan’s rapidly aging
population, and to rein in the developed world’s largest debt.37

36
“Japan suffers worst economic slump in five years,” Agence France-Press, 17 February 2020,
https://www.afp.com/en/news/15/japan-suffers-worst-economic-slump-five-years-doc-1p21on1, accessed 17 February 2020.
37
Y. Takeo and S. Ito, “History Repeats as Sales Tax Hike Pushes Japan Towards Recession,” Bloomberg, 25 February 2020,
https://www.bloomberg.com/news/articles/2020-02-24/history-repeats-as-sales-tax-hike-pushes-japan-toward-
recession?srnd=premium-asia, accessed 25 February 2020.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

EXHIBIT 1: CHANGES IN BOJ’S MONETARY POLICY

2010 Policy rate hit “zero lower bound”.

Lowered short-term nominal interest rate

March 2013 Kuroda assumed office of BOJ Governor

April 2013 BOJ purchased JGBs to lower yield curve.
Government bond purchased to lower yield curve
% of issued JGB held by BOJ

Feb. 2016 Introduction of negative interest rate

Sept. 2016 Introduction of yield-curve control

Source: S. Tani, “The Bank of Japan tries to bend the yield curve,” Nikkei Asian Review, 29
September 2016, https://asia.nikkei.com/Economy/The-Bank-of-Japan-tries-to-bend-the-yield-curve, accessed 21
November 2019.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

EXHIBIT 2: JAPAN’S YEAR-ON-YEAR CPI GROWTH; ALL ITEMS, EXCLUDING

FRESH FOOD %

Source: Compiled from Nikkei, “The Bank of Japan tries to bend the yield curve,” 29 September
2016, http://asia.nikkei.com/magazine/20160929-ASIA300-MVPs-MAJOR-VALUE-
PRODUCERS/Politics-Economy/The-Bank-of-Japan-tries-to-bend-the-yield-curve, accessed 21
November 2019.

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 20/651C Negative Interest Rates: The Bank of Japan Experience

EXHIBIT 3: MONETARY BASE RELATIVE TO NOMINAL GDP

Source: Compiled from Nikkei, (September 29, 2016), “The Bank of Japan tries to bend the yield
curve”,http://asia.nikkei.com/magazine/20160929-ASIA-300-MVPs-MAJOR-VALUE-
PRODUCERS/Politics-Economy/The-Bank-of-Japan-rises-to-bend-the-yield-curve(accessed
November 21, 2019)

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