Negative Interest Rate Policy (NIRP): Japanese Edition

The Bank of Japan shocked many with a surprise move on Friday. They have lowered interest rates below the theoretical "zero lower bound" in an effort to stimulate their ailing economy (25 year bear market)  and to curb the yen which has been rising versus all currencies in the last few months as a flight to safety.  This event should not be overlooked as it is one of the most important policy measures from a major global central in the last 10 years. This paves the way for the rest of the world to follow.  Expect the ECB to act in similar fashion. The Federal Reserve already has had one voting member calling for negative interest rates in 2016 and now Ben Bernanke has come out and said that this should become a policy tool if necessary. 

The US will also have to reassess policy in light of the stronger US dollar.  A strong dollar is a symbol of a strong economy, which is hard to argue in this case due to weak economic data and persistently low inflation levels (points to deflationary headwinds). Dollar strength has had global systemic consequences in the commodity and emerging market complex which the Fed has claimed is only temporary. A definition of temporary is needed as this has lasted well over a year and the damage being done will not be able to reversed quickly.  If the Fed is watching the global markets, which they are, then they might need to rethink dollar/monetary policy in light of the BOJ's latest move to negative rates.  At the very least this puts the US on hold for raising rates any further for the foreseeable future.

Japan is certainly not the first country to toy with negative interest rates, but it is the biggest and coming from a country which has been mired in a bear market for 25 years and used every other tool in its monetary box.  Denmark, Switzerland, Sweden, Austria, Germany, Netherlands have had negative interest rates.  With negative interest rates depositors are paying banks to hold their money for them.  The theory behind this is to incentivize savers to take their money out of deposit accounts bearing no interest and put it to work in places where they can get a better rate of return. Negative interest should also incentivize corporations and small businesses to borrow capital at exceedingly cheap levels and use that money to expand operations.  This is in effect should stimulate economic activity.

Central banks also have incentives for negative interest rates.  I interviewed Professor Miles Kimball, an economist and and Professor of Economics at the University of Michigan,  in 2015 about this: 

"The job of central banks is to keep keep prices stable and to keep the economy on an even keel by keeping output at the natural level. Doing both of these jobs well requires at least occasional use of negative interest rates.

As it is, the Fed, the ECB, the Bank of England, and now the Bank of Japan have a long-run inflation target of 2% because they haven't yet put negative paper currency interest rates in their toolkit. Being prepared to do negative interest rates allows the inflation target to be reduced to 0--true price stability.

And being able to do negative interest rates makes it possible to nip recessions in the bud. These are big enough advantages that I think the eventually most central banks will indeed put negative (and positive) paper currency interest rates in their toolkit."

Rather that doing Quantitative Easing (QE), the theory goes that a central bank should make interest rates negative at 1, 2 or even 3% for a short period of time to have a real impact on economic activity.  That being said, Prime Minister Kuroda and the BOJ is attempting to "nip a recession in the bud" and claw out of a vicious bear market.  Below are some charts of how events unfolded in the last few days. Below is a monthly chart of the Nikkei going back to 1998 right before the giant bubble burst.  The market has not even come close to recovering near its old highs in what has become an extraordinarily long bear market in Japan (25+ years)

One of the key reasons for doing this was to weaken a currency that had been strengthening in recent months. The yen is weakening vs. the USD and all other major currencies. This will help the export sector in Japan and in effect export deflation into Asia. China will not be very happy about this and will have to respond to weaken the yuan further.  This could become tricky for them.  

The yen had been appreciating versus the yuan pretty dramatically in the last few weeks so this was a policy response to that in order to keep Japan competitive.

Industrial production and inflation have both also been lagging tremendously.  Counterintuitively, negative interest will be used to stimulate economic growth and cause they figures to rise. (In theory anyway).

 

 

The yield on Japanese 10 year bond, has sank to lows. This is inversely correlated with the US stock market (so could be a positive going forward):

 

Using negative interest rates in Japan is a historic event and should not be discounted, This could lead the way to the ECB and the Federal Reserve to follow suit.  In poker terms, Japan has gone "all in".  Get your popcorn ready. This could also mark the end of Japan's 25 year bear market. Expect Japan to go even more negative in the coming months. It could also change the bear's tone of imminent global recession calls as central banks react to this news in what will be extraordinary ways.