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Rates are Cut -- But Is It Enough?
Subject Japanese Monetary Policy
Topic International Finance
Key Words Discount Rate, Recession, Economic Growth, Exchange Rates
News Story

Japan's economy has had its ups and downs in the 1990s. Starting with the collapse of the "bubble" economy, an economy with inflated property values and stock prices, in the early 1990s, Japan has had a long recession followed by a modest recovery. In recent months, the unemployment rate has climbed and consumer spending fell, prompting fears that Japan is slipping into recession once again. The possibility of recession was of concern to Japan's central bank as it cut its discount rate for the first time in six years. The Bank of Japan lowered its discount rate to .35 percent from .50 percent. It also announced a series of new lending arrangements designed to avoid a credit crunch.

The magnitude of the rate cut indicates that the move was largely symbolic. Although the discount rate was reduced, only a small amount of assets in the banking system is lent to banks by the Bank of Japan. A more significant policy instrument, the overnight call rate, was left unchanged by the central bank. The discount rate change and announcements of a series of new standby lending arrangements were intended to ease fears of a liquidity crunch, rather than a significant change in the bank's monetary policy.

Since 1995, Japan's central bank has tried a number of policy initiatives to stimulate the economy. In February 1999, it lowered the benchmark interbank rate to almost zero. Last August the bank reversed that policy on evidence that the economy was recovering and that interest-free money was economically distorting. The most recent figures for economic growth show the economy shrinking at a 2.4 percent annual rate in the quarter ending September 30. As other economic data also show that the economy is deteriorating, there have been calls for a return to the zero-interest policy and increases in the money supply. The Bank's actions were seen as a way to increase liquidity without appearing to give in to these demands.

(Updated March 1, 2001)

Questions
1. How do changes in the interest rate affect aggregate demand?
2. What affect does an increase in the money supply have on interest rates? On the economy?
3. If the Central Bank is reluctant to lower interest rates, are there other measures that the government of Japan could adopt to reduce the risk of recession?
4. What affect would lowered interest rates have on the exchange rate between the dollar and the yen?
Source Clay Chandler, "Bank of Japan Cuts Rate, Declines to Take Stronger Action," The Washington Post, February 10, 2001.

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