The Bank of Japan (BOJ) announced on Mar. 19 that it will be ending its negative interest rate policy that has been in place since 2016.

What are negative interest rates?

A negative interest rate policy means you pay interest when you deposit money at the bank, and you earn money for taking out a loan from the bank.

As unintuitive as that sounds, the BOJ implemented it in 2016 as a way of combating deflation.

To be clear, this does not affect everyday retail deposits. Rather, the policy mainly pertains to private banks that park their money at the BOJ.

While deflation, or falling prices, might sound appealing to consumers, it affects corporate revenue. This can lead to a pause on wage raises, and can stifle corporate spending and investment.

This cocktail of falling prices, lower wages, and lower investment may lead to weakened economic growth overall.

Negative interest rates would, in theory, fight this spiral by encouraging banks to lend their money out instead of depositing it, thereby driving up economic activity and bolstering prices.

Understanding this piece of BOJ policy requires a brief detour to the 1990s, when Japan had just experienced a real estate and stock market bubble burst.

The country entered what is now known as the "Lost Decade", a period of long-term deflation and economic stagnation.

In 2013, then-Prime Minister of Japan Shinzo Abe rolled out a comprehensive economic plan to tackle the deflationary slump that had been going on for nearly two decades by then.

This plan was known as the "Three Arrows" of "Abenomics". These arrows were: monetary easing, flexible fiscal policy and a growth strategy including structural reform.

As the International Monetary Fund put it, the goal was "an escape from deflation triggered by monetary easing and fiscal stimulus [that] would lower real interest rates and stimulate investment, consumption and — with, at least temporarily, a weaker yen — exports."

What the government was seeking in the long run was what Haruhiko Kuroda, the Former Governor of the BOJ, called a "virtuous cycle", whereby rising prices, wage hikes, and increased corporate spending would mutually reinforce one another in a positive upward spiral.

In January 2016, the BOJ took key interest rates into the negative for the first time, charging commercial banks a 0.1 per cent fee on their deposited reserves. This then kickstarted the eight-year-old negative interest rate policy that is now finally coming to an end.

Has it worked?

The verdict on the efficacy of the negative interest rate policy is rather mixed.

According to a report by Bloomberg, some experts believe the policy did manage to tackle deflation, while others believe that the effects of the policy were "extremely limited".

Regardless of the policy's effectiveness, Japan is now experiencing inflation, and this has put a strain on consumers.

According to a October 2023 report by Nikkei Asia, voters were "becoming annoyed by the rising cost of living" and are "wondering why the BOJ is still fighting 'deflation' when inflation is so high". 

This is because, as a report by The Wall Street Journal points out, wage increases have not kept pace with inflationary prices.

Public dissatisfaction has therefore put pressure on the government to temper the effects of inflation.

What's the significance of an upcoming wage hike?

Every year in March, Japanese unions engage in wage talks with representatives from the major Japanese firms, bargaining for raises.

These talks are known as shuntō, translated directly as "spring wage offensive".

The Japan Times reported that this year's shuntō has led to a massive planned wage hike.

The Japanese Trade Union Confederation, otherwise known as Rengo, announced a huge preliminary wage hike figure of 5.28 per cent, which would actually be a 33-year high, and a huge jump up from the wage raise of 3.58 per cent the previous year.

According to the Financial Times, this major wage hike gave the Governor of the BOJ, Kazuo Ueda, the "confidence" that mild inflation will continue, and that a "virtuous cycle" will take off, with increased wages leading to increased household spending.

In turn, the BOJ decided to slowly raise interest rates and pull them out of the negative.

What are the consequences?

According to Bloomberg, the Japanese government is likely to suffer since higher interest rates will raise the government's debt servicing costs.

The Japanese government currently holds the world's largest public debt load at 1,286.45 trillion yen at the end of 2023, nearly twice the size of its economy.

There is also the question of the roughly 3 trillion yen that is currently parked overseas by Japanese investors.

These investors previously looked abroad to avoid the negative interest rates back home.

According to an expert interviewed by Reuters, however, it is unlikely that these investments will be repatriated anytime soon even as interest rates rise.

Another thing to be affected by the announcement is the value of the yen.

According to FT, the announcement led to a momentary dip in the yen as it slid 0.8 per cent against the US dollar to 150.33 yen. 

Nevertheless, a rise in interest rates is likely to lead, in the long-term, to a strengthening of the yen.

This would mean cheaper imports for Japan, but could also undermine the competitiveness of Japanese exports overseas.

Moreover, while Japanese tourists will probably enjoy the increased spending power of their strengthened yen, it is also likely going to be costlier for foreigners (including Singaporeans) to travel to Japan.

Top photo via Unsplash and Bank of Japan