Why is Japan the only major economy that maintains negative interest rates and what are the consequences for the country?

 While the United States has skyrocketed interest rates this year to rein in high inflation, the world’s major central banks have embarked on a similar crusade. Except one: Japan.

Swimming against the current, the third largest economy in the world has maintained an interest rate of -0.1%, although the country reached an inflationary level of 3%, the highest since 1991 (excluding the jump in 2014, when prices fell affected by a sales tax increase).

In many countries around the world, 3% inflation would be minimal (just ask Argentina which is currently dealing with an 83% cost of living increase).

But by Japan’s standards, this is the highest inflation in decades.

At the same time, the Japanese currency, the yen, is in free fall.

Conventional economic prescriptions say that an increase in interest rates could alleviate both problems. However, many are not convinced that this is the solution for the Asian country.

With much of the current inflationary pressure coming from the strong dollar and rising energy and food imports, some economists believe the Japanese authorities’ room for maneuver is rather limited for now.

And while a rate increase could partially help the country get closer to its 2% annual target, what is not clear is that it will stop the yen’s slide.

In other countries, rate hikes by their central banks have done little to protect their own currencies against the mighty dollar at this juncture.

What is a negative interest rate used for?

Negative interest rates seek to reactivate the economy.

In practice, this means that a country’s central bank, which is the monetary authority, charges commercial banks for some of the reserves they hold in the institution.

Since it is more costly for commercial banks to hold reserves, the measure is designed to encourage banks to use those reserves to lend to entrepreneurs in an effort to revive economic activity.

The Bank of Japan argues that making credit more expensive now would only suppress already weak demand and delay a fragile post-pandemic recovery.

“Good” inflation

The history of Japan has its own ins and outs that set it apart from the rest.

For years the country was mired in an agonizing deflation (a general decline in prices) that contributed to economic stagnation.

Haruhiko Kuroda, governor of the Bank of Japan, insists that the economy is too weak to raise rates.

Precisely what Japan needed was an increase in the cost of living to stimulate economic growth. However, say analysts, the inflation that exists today in Japan is not a reflection of a true recovery, but rather the result of the external crisis and the fall of the yen.

From this point of view, what Japan would need is “good inflation,” the kind created by strong consumer demand.

But the current one is a kind of “bad inflation,” experts say, the kind created by a strong dollar and product shortages related to the pandemic and the war in Ukraine.

The central bank considers that this increase in prices is temporary and therefore prefers to keep rates below zero.

That’s why the chief monetary officer, Haruhiko Kuroda, has insisted that the economy is too weak to handle higher interest rates.

The plummeting yen

Traditionally, the yen has always been considered a refuge in times of storms and that is why every time there is a crisis, investors protect themselves by buying the Japanese currency.

But that status is now in question.

This year alone, the currency has lost a fifth of its value against the dollar, reaching its lowest price since 1990.

This year alone, the yen has lost a fifth of its value relative to the dollar.

Why? The yen’s fall has been driven by the difference between interest rates in Japan and the US.

While the world’s largest economy has aggressively raised its interest rate to 3.25%, Japan has remained below zero.

Higher interest rates tend to make a currency more attractive to investors.

As a result, there is less demand for currencies from countries with lower rates, and those currencies lose value.

Some experts believe that the weak yen also reflects the state of the country’s finances, with an economy that has barely grown in the last three decades.

To this we must add that Japan is the most indebted country in the world and that it is carrying a demographic time bomb due to its low birth rate.

The government has allowed some foreign workers to help address the problem of an aging population, but there is still strong opposition to immigration policies.

“There is no reason for the yen to get stronger,” Takeshi Fujimaki, a former adviser to billionaire investor George Soros.

Japan had not intervened in the foreign exchange market to prop up the yen for almost two and a half decades.

However, last month, when the currency fell, the authorities stepped in and spent $21 billion. The move helped for a short time, but soon the currency fell again, this time crossing 150 yen to the dollar.

Some reports indicate that he had to intervene again, says Mariko Oi, although the Japanese government denies this.

In any case, local analysts consider that this type of intervention can only have specific effects.

“It’s to show the Japanese government’s position that they don’t want further weakening of the Japanese yen,” says Eisuke Sakakibara, a former senior official at Japan’s Finance Ministry.

The umaibo variable

Any country whose currency loses value faces adverse effects. The weak yen has made everything Japan buys abroad more expensive.

The country is highly dependent on imported oil and gas. Due to exchange rates and rising energy prices, the amount of money you spent on imports last month increased by 46%.

But on the plus side, the money Japanese exporters make abroad is worth much more at home. With exports accounting for about 15% of the country’s total economic activity, it’s a boon amid bad news.

From a consumer point of view, the Japanese have lost half their purchasing power over the last decade, triggering a serious problem because average wages in Japan have hardly increased in more than three decades.

Today’s inflation, although only running at 3% compared to other developed countries that have levels above 10% per year, is something that the Japanese were not used to.

A big surprise was the 20% rise in one of the most common snacks in Japan, umaibo, a product that has always been priced at 10 yen (US$0.075) since its creation 43 years ago.

Such was the impact that Yaokin, the company that makes the popular snack, had to launch an advertising campaign explaining why it was forced to raise the price.

As was inevitable, one by one the products have gone up in value. According to the Teikoku data bank, the prices of more than 10,000 food products will increase by an average of 13% this year.

“Consumers are not used to accepting inflation,” Takeshi Niinami, chief executive of Suntory Holdings, a company known for Japanese whiskeys Yamazaki, Hibiki and Hakushu, as well as beer and soft drinks like bottled water and coffee.

That discontent is a challenge that will have to be faced by the government of Prime Minister Fumio Kishida, who has so far fully supported the central bank’s decisions on maintaining interest rates.