Today the Bank of Japan (BoJ) took another step in its struggle to generate higher inflation by moving to negative interest rates. More than likely, this will not be the last step for the BoJ. The key question remains: will it work?
Today the BoJ cut its policy rate from 0.1% to -0.1% (actually the negative rate will only apply for a part of the bank reserves held at the BoJ). After several years of policy rates close to zero and a massive program of asset purchases, this is another step in the BoJ’s attempts to generate higher inflation. The promise, made in Spring 2013 (and highly doubtful at the time), to reach the 2%-inflation target in two years’ time has clearly not been fulfilled. Inflation currently stands at 0.2%. The BoJ explicitly stated its willingness to go even further if necessary. It’s highly likely that it will do so in coming quarters.
The key question obviously remains whether or not the efforts of the central bank will ever work. As monetary policy of this extent has never been tried in any economy, this remains very much open for debate. That said, some lessons have been learned in recent years.
- Monetary stimulus can be very effective in times of acute crisis (like Lehman Brothers or the eurocrisis). To restore the economy back to normal once the immediate crisis has eased, monetary policy seems far less potent (especially if the economy is stuck in a liquidity trap). As such, it is best for the central bank to act aggressively during the acute phase of the crisis. In this respect, the BoJ has waited far too long with its aggressive moves. Still, probably better late than never.
- The traditional risks linked to an overly loose monetary policy, mainly setting off a surge in inflation or creating bubbles in financial or real estate markets, are of little concern for Japan. After more than a decade of deflation/ultra-low inflation a surge in inflation still seems like a faraway dream for Japan. Bubbles in Japan’s financial or real estate markets are even further away.
As such, it’s not so farfetched that the BoJ tries to do whatever it can (even if it is quite late to do so). However, one crucial issue remains: the state of perma-stagnation of the Japanese economy is clearly to a considerable extent linked to the ageing of its population. And monetary policy is not well-equiped to counter the effects of the latter. It remains to be seen how effective monetary policy can ever hope to be against such a demographic backdrop. As such, Japan remains an interesting test case for what will be possible in Europe, where the population is also ageing (albeit to a lesser extent).