South-Western College Publishing - Economics  
Interest Rates in Japan a Zero
Subject Interest rates
Topic International Finance
Monetary Policy
Key Words Monetary Policy, Interest Rates, Inflation, Economic Growth
News Story

Interest rates in Japan have been almost zero since February 1999. The policy was adopted at that time as an emergency measure to assist Japan's ailing economy. It was expected to only be a temporary measure with interest rates rising as soon as the economy responded to the stimulus. Even though there are signs that Japan's economy is recovering, the zero interest rate policy remains in effect, and policy makers at Japan's central bank have just voted to keep interest rates at their current level.

Interest rates at or near zero are clearly an abnormal occurrence. Policy makers in Japan had expected that their decision in February 1999 to lower rates to zero would soon be rescinded. After many months of economic uncertainty, Japan's economy finally seems to be recovering from its worst period of protracted weakness since World War II, and there was speculation that policy makers would react by nudging interest rates up. The central bank announced however, that it would keep interest rates at their current level because of continued uncertainty about employment and wages.

Economists, some government officials and businessmen had argued that the government lacked a rationale for a change in interest rates. Increasing interest rates, they argued, could stop the expansion. A number of Japanese business enterprises are saddled with very large debt. Raising interest rates will make it more difficult for these firms to repay their debt and will increase the probability of business failures. Sogo, a large department store, just announced it would close under the weight of $17 billion in loans that it could not repay.

A zero interest rate monetary policy can lead to inflation as consumer and investor demand lead to increased production and prices. This is not yet the case in Japan. Prices are falling, consumer spending is erratic and although business investment has increased, businesses are not financing this investment by borrowing.

(Updated August 1, 2000)

1. What are the determinants of the demand for loanable funds, that is, what determines how much firms and consumers are willing to borrow at various interest rates? (Assume government demand is zero)
2. What are the determinants of the supply of loanable funds, that is, what determines how much firms and consumers are willing to borrow at various interest rates? (Assume government supply is zero)
3. What is the likely impact of an increase in Japan's interest rate on the nation's exchange rate?
Source Stephanie Strom, "Japan Keeps Interest Rates Near Zero," The New York Times, July 18, 2000.

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