Japan Goes Negative; Economists Scoff

Experience shows muted economic impact.

Reviewed by: John O'Donnell
Edited by: John O'Donnell

Frankfurt (Reuter) – Japan's move to cut interest rates into negative territory will do little to lift the country out of the doldrums, economists said, pointing to the modest impact of similar steps by European countries on their weary economies.

On Friday, Japan followed the European Central Bank in cutting a benchmark interest rate below zero, imposing a penalty charge on banks that park money with the institution.

Economists, however, said this tactic had seen limited success in the eurozone, Sweden or Denmark, where similar charges have been imposed to encourage banks to lend in the hope of buoying the economy and averting deflation.

Efforts Will Fail

"I think these efforts in Europe and Japan are failures," said Richard Koo of the Nomura Research Institute in Japan.

"The private sector is not borrowing money at any interest rate. This entire exercise is not going to work," said Koo, who argued that only a cleanup of bad loans would lift lending and the economy.

The eurozone's 19 members, from Germany to Greece, have considerable experience with a negative deposit rate.

ECB President Mario Draghi cut this rate below zero for the first time in the middle of 2014, effectively charging banks that park money overnight with the ECB. It was reduced again in December, and a further cut is expected in March.

Rather than serving as testimony to the ECB's ability to act, many economists believe it shows the opposite; namely, that it has few other alternatives after the launch of an ambitious money-printing program to budge inflation.

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‘Smoke Screen’

Daniel Gros, who heads the Centre for European Policy Studies think tank in Brussels, dismissed such moves as a "smoke screen."

"We know that small changes in the interest rate have an extremely limited impact on investment," he said.

While negative rates have lifted lending in the eurozone, in particular for home buying, inflation remains at just 0.4%, far off the ECB's 2% goal.

Other countries report a similar experience.

In early 2015, Sweden introduced negative rates, imposing a penalty charge on banks. But the northern European country has seen only modest economic improvements.

While price inflation, stripping out the cost of mortgages, climbed through the year to around 1%, it recently fell back slightly. Steady price inflation is seen as a gauge of economic health.

Denmark, whose currency is pegged to the euro, introduced similar cuts to rates at the start of last year, but the impact was marginal, and it recently reversed course.

"I don't think this is going to cure the deeper problem in Japan," said Thomas Thygesen, an economist in Copenhagen with Swedish bank SEB.

Helps Homebuyers, Not Business

Even worse, negative rates can prompt excessive lending to home buyers rather than companies, where credit is most needed to spur investment and the economy.

House prices in Stockholm, like in many cities in Germany, are rising fast, prompting warnings of a property bubble.

Francesco Papadia, a former senior ECB manager, cautioned that the impact of negative rates is limited partly because cutting them too low would prompt savers to keep money 'under the mattress'.

"There is a limit to how negative interest rates can go because they otherwise would encourage people to hoard banknotes," he said.

"So while negative rates can help, the cuts as well as the impact can only be small."