While the global economic landscape is threatened by the latest economic disruptions, world’s main Central Banks are trying to figure out the right policy to implement in order to boost their economies. The issue consists in how to use the monetary tool to obtain the desired effect. Each alternative has its pros and cons, but it is up to each country to elect what best fits its needs.
Different concerns have influenced the decision of different central banks leading them to follow different routes. While Janet Yellen opted for a rate hike, abandoning, for the first time after the financial crisis, the close-to-zero benchmark, on the other hand the European Central Bank seems to be targeted to its quantitative easing policy, pushing interest rates lower and lower. In the middle of the two fires, the Bank of Japan decided to follow the European example and use expansionary monetary policy to push interest rates down to a negative value of 0.1%. This unprecedented, at least for Japan, move may seem like an act of desperation, a signal that traditional remedies have proved ineffective and thus new frontiers have to be explored. European and Japan Central Banks are surely making a bid but if it works it will pave the way to a new powerful tool to reinvigorate the economy.
This brand new technique, however, as not fully tested, has generated great concerns. Theoretically speaking, Central Banks are limited in their use of expansionary policy because when interest rates fall below zero they lose their effectiveness as people prefer holding money, which yields a zero return in any case. By the way, empirical evidence suggests that institutions and individual are willing to accept negative rates of interest and that therefore zero is not a binding floor.
Given that negative rates are possible; Japanese Central Bank has in mind to use them to spur economic growth. The reduction in the cost of borrowing both for firms and households is expected to drive an increase in the demand for loans.
Actually, two different outcomes could verify depending on how banks will react to the interest rate cut. The cost of this policy will have to be eventually borne by someone. Either credit institutions may decide to make customer pay to hold their cash in deposits, or they may squeeze the spread between their lending and deposit rate, shrinking their profits. And, moreover, it is not sure that in case the latter occurs the result will be increased confidence together with fostered growth, and not a restriction in the willingness to lend of banks. The hope of Bank of Japan is that banks, restricted in their ability to make profits, would be willing to take more risk in search of more profitable opportunities. This would obviously imply and extension of loans also to weaker parties and an eventual increase consumption and spending.
In the case in which the result of negative interest rates would be a cut in lending, there is risk that they will cause more harm than good. Great concern characterizes the Japanese economic climate of nowadays, and not everyone is in line with the decision. However, the Bank of Japan firmly defends its line of action as strongly convinced of the fact that quantitative easing will, eventually, have its desired effect. The mechanism should be the same of that of a reduction in rates even if in a much risky territory. Up to now positive responses have not yet materialized. The common purpose of both Japanese and European policy makers is that of rising consumption and preventing further deflation; but, at the same time, Japanese latest downward wage negotiations reflect that people are actually not expecting an increase in prices. Economists all around the world are following the evolution of the Japanese economy to see whether negative interest rates could be the solution to problems or not. This is surely a bet whose effects will only be clear as soon as they will arrive.
Fiammetta Galzerano
Different concerns have influenced the decision of different central banks leading them to follow different routes. While Janet Yellen opted for a rate hike, abandoning, for the first time after the financial crisis, the close-to-zero benchmark, on the other hand the European Central Bank seems to be targeted to its quantitative easing policy, pushing interest rates lower and lower. In the middle of the two fires, the Bank of Japan decided to follow the European example and use expansionary monetary policy to push interest rates down to a negative value of 0.1%. This unprecedented, at least for Japan, move may seem like an act of desperation, a signal that traditional remedies have proved ineffective and thus new frontiers have to be explored. European and Japan Central Banks are surely making a bid but if it works it will pave the way to a new powerful tool to reinvigorate the economy.
This brand new technique, however, as not fully tested, has generated great concerns. Theoretically speaking, Central Banks are limited in their use of expansionary policy because when interest rates fall below zero they lose their effectiveness as people prefer holding money, which yields a zero return in any case. By the way, empirical evidence suggests that institutions and individual are willing to accept negative rates of interest and that therefore zero is not a binding floor.
Given that negative rates are possible; Japanese Central Bank has in mind to use them to spur economic growth. The reduction in the cost of borrowing both for firms and households is expected to drive an increase in the demand for loans.
Actually, two different outcomes could verify depending on how banks will react to the interest rate cut. The cost of this policy will have to be eventually borne by someone. Either credit institutions may decide to make customer pay to hold their cash in deposits, or they may squeeze the spread between their lending and deposit rate, shrinking their profits. And, moreover, it is not sure that in case the latter occurs the result will be increased confidence together with fostered growth, and not a restriction in the willingness to lend of banks. The hope of Bank of Japan is that banks, restricted in their ability to make profits, would be willing to take more risk in search of more profitable opportunities. This would obviously imply and extension of loans also to weaker parties and an eventual increase consumption and spending.
In the case in which the result of negative interest rates would be a cut in lending, there is risk that they will cause more harm than good. Great concern characterizes the Japanese economic climate of nowadays, and not everyone is in line with the decision. However, the Bank of Japan firmly defends its line of action as strongly convinced of the fact that quantitative easing will, eventually, have its desired effect. The mechanism should be the same of that of a reduction in rates even if in a much risky territory. Up to now positive responses have not yet materialized. The common purpose of both Japanese and European policy makers is that of rising consumption and preventing further deflation; but, at the same time, Japanese latest downward wage negotiations reflect that people are actually not expecting an increase in prices. Economists all around the world are following the evolution of the Japanese economy to see whether negative interest rates could be the solution to problems or not. This is surely a bet whose effects will only be clear as soon as they will arrive.
Fiammetta Galzerano