Japanification: The issue of negative interest rates

Before the advent of the pandemic and the global recession that ensued, Japan was battling an economic uphill battle against negative interest rates. In the 1990s, Japan’s national GDP was approximately 4.9 Trillion USD; in 2020, Japan’s national GDP is still approximately 4.9 Trillion USD. Because of the lack of economic growth and lackluster activity, The Bank of Japan (Japan’s central bank) had cut interest rates so low that they are currently in the negatives (-0.1%). This, essentially, means the country’s monetary policy consists of the state paying other banks to borrow money in order to prevent economic contraction and deflation.

The issue with this method is that, first, it is exorbitant and drains public funds that are increasingly being allocated to Japan’s aging population, and second, it leaves the countries’ central bank with little to no tools to mitigate economic downturns—like a pandemic induced recession. When a county's central bank is no longer an effective instrument to combat economic contraction, the county must rely on fiscal policy alone—i.e., taxes, public spending, and debt—or foreign assistance.

The dilemma with foreign aid is that this aid would presumably come in the form of international loans from, either the IMF or World Bank, and Japan already holds an overwhelming amount of national debt. Japan’s national debt is 12.3 Trillion USD: nearly 250% its GDP; for contrast, USA’s national debt was just a little over 100% its GPD (pre-pandemic).

With pre-existing negative interest rates, Japan is in a worst position to persist through this crisis than the 2008 financial crisis. Japan’s economy was already on the precipice of decline because of multi-decade-long stagnation, entitlements, and enormous public debt. Japan is likely not to recover from this global recession and its economy will continue its spiral downward and flirt with deflation.

Deflation terrifies central bankers far more than inflation because as long as inflation is stable, it can be predicted, controlled, and managed—it is even conducive to economic growth. Though, since deflation leads to the decrease of prices in an economy and an increase to the value/buying power of an individual’s money, that individual will hold on to that money and wait for it to appraise further instead of spending and consuming. In addition, deflation and lower prices cause business profits to decrease, and in consequence, leads to wages/expenses being cut. Therefore, those whose wages were cut will instinctively save more and spend less, and future financial uncertainty will cause others to do the same.

As a result, the decrease in activity and increase in saving will cause the national economy to grind to a stop. If that scenario of deflation continues, it naturally leads to economic contraction (i.e. a recession). In a modern economy, modest recessions are expected and somewhat routine. Although, that is where a central bank intervenes and uses its tools to mitigate the economic downturn and help stimulate its economy.

One of the tools a central bank used is adjusting interest rates; they do this by setting the rate it cost other banks to borrow from them, and unlike normal banks with a finite amount of cash, a central bank has, in theory, an unlimited amount of cash to lend out. The lower the rate, the more banks are willing to borrow. That is the issue with preexisting negative interest rates. Once a central bank’s rates are near-zero or negative, they can no longer use that tool as a remedy to offer to the economy and save it from spiraling further downward.

Consequently, in the summer of 2020, Japan’s longest-serving Prime Minister, Shinzo Abe, resigned from office because he believed he was no longer healthy enough to steer Japan through its precarious economic future.