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Economy

What Europe's experience tells us about the BOJ's experiment

TOKYO -- The Bank of Japan hopes its negative interest rate will help to boost prices. Haruhiko Kuroda, the central bank's governor, argues the policy will spur consumption and capital spending. But do negative interest rates work? And what side effects come with them?

     We can look to Europe for some answers. From 2012 to 2015, the central banks of Denmark, Switzerland and Sweden all introduced negative rates, as did the European Central Bank.

     Negative rates can affect an economy in two ways. First, by pulling down interest rates on loans, they can encourage capital and housing investment. They also promote the transfer of money from low-yield government bonds to foreign securities, weakening local currencies and pushing up stocks.

     Indeed, the introduction of negative interest rates led to a sharp decline in bank lending rates in Europe. As a result, bank lending in the eurozone, which had been declining at an on-year rate of nearly 3%, picked up.

     Yet there is more to the story. The increase in European lending has been modest, primarily due to weak demand for funds. Some banks have also been reluctant to extend higher-risk loans, since low rates have squeezed their profit margins. 

     "Negative interest rates held back the growth of loans," said Mizuho Securities economist Kenta Ishizu. In Denmark, some banks raised rates on housing loans to secure revenue.

     Many market experts believe that, to some degree, negative interest rates have propped up prices. Still, even a positive cycle of loan growth, investment and demand can only do so much. Prior to the crude oil slump, inflation rates were already hovering around 0%, and projected inflation remains low in most European countries.

Best-laid plans

One of the hidden side effects of a negative rate policy can be a worsening of household sentiment. In Switzerland and the two Scandinavian countries, household savings rose rapidly as policy rates dropped. Consumers cut spending out of fear that their retirement savings would take a hit from low interest rates, according to a Bank for International Settlements study. 

     If such fears snowball, negative rates can pull down demand and prices, contrary to central banks' intentions.

     Meanwhile, negative rates can greatly affect the currency markets. In the year after the ECB went negative, in June 2014, the euro fell about 5% against major currencies. "Investors shifted their money to U.S. Treasurys and other foreign assets," said Kenichiro Yoshida, senior economist at the Mizuho Research Institute.

     The softer euro improved the profitability of European companies and helped boost stock prices by 10% over the course of a year. This is why some market watchers are saying the BOJ's real goal was to weaken the yen.

     Trouble is, currency and stock markets are swayed by many factors. The BOJ's decision initially sent the yen lower and Japanese stocks higher, but the effect was short-lived. Uncertainty about the Chinese and U.S. economies triggered another bout of market turmoil.

     The differences between the European and Japanese economies cannot be ignored, either. Japan's financial system is stronger than Europe's, but a two-decade economic slump has made the nation's companies and consumers extremely cautious. "Even if interest rates decline further, funding demand is unlikely to increase," said President Izuru Kato of Totan Research.

     Kuroda has said the BOJ's quantitative and qualitative easing program, coupled with a negative rate, is "the most powerful monetary policy framework in the history of modern central banking." The governor has shown a willingness to be aggressive when the situation calls for it. Yet few central banks have tried negative rates, and the jury is divided over the results in Europe.

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