Why Negative Interest Rates Are Still Not Working in Japan

The Bank of Japan (BOJ) keeps trying to print Japan back to economic prosperity, and it is not letting more than 25 years of failed stimulus policies get in its way. The BOJ announced negative interest rates in January 2016 as an iteration in monetary experimentation. Six months later, the Japanese economy showed no growth, and its bond market was a mess. Conditions deteriorated so far that the Bank of Tokyo-Mitsubishi UFJ Ltd., Japan's largest private bank, announced in June 2016 that it wanted to leave the Japanese bond markets because BOJ interventions had made them unstable.

While these economic woes presented major problems for then-prime minister Yoshihide Suga and then-BOJ Governor Haruhiko Kuroda, they can serve as a cautionary tale for the rest of the world. Chronically low interest rates and huge monetary expansions failed to promote real economic growth in Japan. Quantitative easing (QE) did not achieve its stated objectives in the United States or the European Union (EU), nor have chronically low interest rates been able to revive Japan's once-thriving economy.

Why Japan Went Negative

There are two reasons why central banks impose artificially low interest rates. The first reason is to encourage borrowing, spending, and investment. Modern central banks operate under the assumption that savings are pernicious unless they immediately translate into new business investment. When interest rates drop to near zero, the central bank wants the public to take their money out of savings accounts and either spend it or invest it. This is based on the circular flow of income model and the paradox of thrift. Negative interest rate policy (NIRP) is a last-ditch attempt to generate spending, investment, and modest inflation.

The second reason for adopting low interest rates is much more practical and far less advertised. When national governments are in severe debt, low interest rates make it easier to afford interest payments. An ineffective low-rate policy from a central bank often follows years of deficit spending by a central government.

No country has proven less effective with low-interest-rate policies or high national debt than Japan. By the time the BOJ announced its NIRP, the Japanese government's rate was well over 200% of gross domestic product (GDP).

Japan's debt woes began in the early 1990s, after Japanese real estate and stock market bubbles burst and caused a steep recession. Over the next decade, the BOJ cut interest rates from 6% to 0.25%, and the Japanese government tried nine separate fiscal stimulus packages.

The BOJ deployed its first quantitative easing in 1997, another round between 2001 and 2004, and quantitative and qualitative monetary easing (QQE) in 2013. Despite these efforts, Japan had almost no economic growth for more than 25 years.

Why Negative Interest Rates Do Not Work

The Bank of Japan is not alone. Central banks have tried negative rates on reserve deposits in Sweden, Switzerland, Denmark, and the EU. As of July 2016, none had measurably improved economic performance. The U.S. later followed suit, bringing interest rates to the 0% to 0.25% range in March 2020 in response to the pandemic, but rapidly hiking them again once the crisis was over.

Low interest rates are designed to warm up the economy, increase spending and investing, and encourage borrowing. But super-low interest rates do little for indebted governments, and even less to make businesses more productive or to help low-income households afford more goods and services. Super-low interest rates do not improve the capital stock or improve education and training for labor. Negative interest rates might incentivize banks to withdraw reserve deposits, but they do not create any more creditworthy borrowers or attractive business investments.

Japan's NIRP certainly did not make asset markets more rational. By May 2016, the BOJ was a top 10 shareholder in 90% of the stocks listed on the Nikkei 225.

The Bottom Line

There appears to be a disconnect between standard macroeconomic theory, by which borrowers, investors, and business managers react fluidly to monetary policy, and the real world. The historical record does not kindly reflect governments and banks that have tried to print and manipulate money into prosperity. This may be because currency, as a commodity, does not generate an increased standard of living. Only more and better goods and services can do this, and it's clear that circulating more bills is not the best way to make more or better things.