Bank of Japan launches negative interest rates Feb 16, 2016 Central bank encouraging banks to lend, businesses to invest and savers to spend.

The Bank of Japan’s negative interest rates came into effect on Tuesday in a radical plan already deemed a failure by financial markets, highlighting Tokyo’s lack of options to spur growth as global markets sputter.

The central bank, which announced the shock decision on 29 January, will charge banks 0.1% for parking additional reserves with the BOJ to encourage banks to lend and prompt businesses and savers to spend and invest. While the announcement briefly drove down the yen and buoyed Japanese share prices, markets quickly went into reverse.

“It’s getting clearer that Abenomics is a paper tiger,” said Seiya Nakajima, chief economist at Office Niwa, a consultancy, referring to prime minister Shinzo Abe’s policy mix of monetary easing, spending and reform. “The impact of monetary easing is similar to currency intervention. The first time they do it, there’s a huge impact. But as they repeat it, the impact will wane,” said Nakajima.

Though senior BOJ officials were at pains to say they had calibrated only a minor impact on Japanese banks, their stock prices plunged, contributing to a global market sell-off, particularly in financial shares.

The problem was partly bad timing, as global markets were already in a tailspin over concerns about China’s slowdown, US rate hikes and tumbling oil prices. But the reaction leaves BOJ governor Haruhiko Kuroda’s assertion that his policy is having its intended effects looking increasingly threadbare.

“It seems as though the BOJ’s action triggered the market moves,” said Yoshinori Shigemi, global market strategist at JPMorgan Asset Management. “But a better explanation would be that concerns elsewhere overwhelmed the BOJ action.”

In the 11 days since the BOJ board’s announcement, the benchmark Nikkei index has fallen 8.5%, despite a sharp rebound on Monday, while the yen has climbed 6.5% against the dollar.

Japanese bank shares have slumped by as much as 30% as they are unlikely to pass on negative rates to savers, who already get negligible interest on their deposits but would baulk at paying to save. Negative rates could push down bank operating profits by 8-15%, Standard and Poor’s said.

The 10-year Japanese government bond yield initially fell below zero on the easing – a first among Group of Seven economies. But it has recovered from minus 0.035% last week to 0.090% above zero, with Japanese markets becoming more unstable as investors are at a loss on how to estimate fair value.

Although the rate is likely to fall to negative levels eventually, it is unlikely to fall below zero for now, partly because many banks have not yet fixed their trading system to cope with negative interest rates.

“At the moment, no one seems willing to lend at negative rates ... The BOJ decided to introduce negative rates so suddenly without giving banks time to prepare for them,” said Keita Higano, market economist at Totan Research. Read the above news bulletin and answer following questions.

1. What are the Central bank’s objectives of launching negative interest rates? Explain carefully using diagrams of aggregate demand and aggregate supply how this action will help to achieve objectives set by the Central bank.

2. What are the expected impacts on the Japanese stock market? What changes do you expect in the Japanese consumption, investment and on overall aggregate demand?

3. What are the possible reasons for not being able to fully successful (as anticipated) with this policy initiative as discussed in this bulletin?

4. Instead of the monetary policy, what is the other active stabilization policy that you propose to achieve the central bank’s objective by the Japanese government? Explain how that policy works using diagrams.

5. Provide examples of a government policy that act as an automatic stabilizer? Explain why the policy has this effect.