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Japan's central bank, feeling a little wacky last week, loudly promised not to cut interest rates below zero and then almost immediately cut interest rates on excess reserves below zero.
This is a little bit different from the phenomenon of negative interest rates that materialized in Europe last year, but it's closely related.
And it's worth paying attention to, because Japan is in some ways the canary in the coal mine for demographic conditions all around the world — offering a preview of what older, rapidly aging economies may start to look like elsewhere.
What Japan actually did
Long story short, banks will be charged a small fee for parking extra money with the Bank of Japan.
Banks take in deposits and then turn around and lend out the money again, but obviously they can't lend out all of the money again or else depositors would never be able to get their money back. The money that banks keep on hand is called reserves. And while some of those reserves are actual paper money sitting around in bank branches ("vault cash"), most of it is electronic money that is kept on deposit at the central bank.
Countries normally regulate how much money banks are required to keep on reserve, and that money is conveniently known as "required reserves."
But sometimes banks hold more money in reserve than is legally necessary. Those are excess reserves. Just as regular banks pay interest on the money you keep in your bank account, central banks can pay interest on excess reserves that banks keep in their accounts with the central bank.
But while a retail bank's interest rates are set by business considerations, the central bank's decision about interest on excess reserves is driven by policy considerations.
What Japan did was change policy and say that going forward, new excess reserves are going to carry a slightly negative interest rate. In effect, banks will be charged a fee for stashing cash with the Bank of Japan.
Why is Japan doing this?
It's not entirely clear. In both Europe and especially the United States, the current thinking about central banking is that it's important to be as clear and communicative as possible about what is going on and why.
But Bank of Japan president Haruhiko Kuroda is from a different school of thought, which holds that monetary policy actions are more effective if they're surprising — hence lying about what he was considering earlier in the week. And that means he doesn't explain his actions as thoroughly as some of his counterparts.
But broadly speaking, the idea here is to stimulate the Japanese economy.
Penalizing banks for stashing extra cash with the central bank is supposed to encourage more lending, more investment, and more economic activity, which is needed because Japan's economy keeps tilting into recession.
On the other hand, Japan's 3.3 percent unemployment rate is already very low, so it's not entirely clear that the economy can be stimulated at all.
The basic issue in Japan is that Japan's working-age population is shrinking rather rapidly, meaning it can easily go into recession without actually losing jobs.
All that said, inflation in Japan is nearly nonexistent, so there doesn't seem to be any clear harm in trying further stimulus.
How this relates to the US
Economic conditions in the United States are different from those in Japan. Our working-age population is growing, and our unemployment and inflation rates are higher. But the trends in the United States all point in a Japan-esque direction. Our population is aging, and both interest rates and inflation are lower than their historical levels.
One important question this raises is what would or could the Federal Reserve do if our economy was hit by a new recession. Conventional interest rates are still so close to zero that there's not much to be accomplished by cutting them further. But the interest the Fed pays on excess reserves could certainly be cut like Japan just did — even into negative range.
That's not a tool then-US Fed Chair Ben Bernanke felt comfortable using during the Great Recession, perhaps in part because at the time it was a completely hypothetical idea.
Japan, however, is about to field-test the results in a large economy — and the results are something American officials will be looking at closely.
Go deeper:
- Read more: Your travel guide to Japan on Meridian.net.
