Haruhiko Kuroda: Answers to Frequently Asked Questions on
"Quantitative and Qualitative Monetary Easing (QQE) with a Negative
Interest Rate"
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the
Yomiuri International Economic Society, Tokyo, 7 March 2016.
* * *
Accompanying charts can be found at the end of the speech.
Introduction
It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic
Society today.
At the end of January, the Bank of Japan decided to introduce "Quantitative and Qualitative
Monetary Easing (QQE) with a Negative Interest Rate," which added the new dimension of "a
negative interest rate" to the existing policy of QQE. Specifically, the Bank applies a negative
interest rate of minus 0.1 percent to current accounts that financial institutions hold at the
Bank. This measure enables the Bank to now pursue additional monetary easing by
providing the new option of "a negative interest rate" in addition to the "quantitative" and
"qualitative" measures used so far. Some market participants had voiced doubts that a
further expansion of QQE would be possible, arguing that QQE had reached its limit, but I
think such views have been completely dispelled.
"QQE with a Negative Interest Rate" will have an impact on financial institutions, financial
markets, and, more broadly, people's lives in general. Moreover, as the term itself, "negative
interest rate," sounds somewhat shocking, the measure has been the focus of attention in
the newspapers and on TV day after day. Given the wide impact - on financial markets, the
management of financial institutions, and people's everyday lives - it will have, the measure
has given rise to a variety of questions and concerns. Today, I would like to explain the
Bank's thinking with regard to this policy and respond to frequently asked questions.
I. Benefits for households and firms
Are there benefits for households and firms?
To start with, I would like to explain the benefits of "QQE with a Negative Interest Rate" for
households and firms. The media has been reporting that while interest rates on housing
loans have declined, deposit interest rates have also declined, asking whether the net impact
of the policy for households is negative or positive. The answer is very clear. Individuals and
firms as a whole will definitely benefit from this policy (Chart 1). Deposit interest rates are
declining, but the extent of the decline is minimal, since rates already were close to
0 percent. For example, interest rates on deposits in ordinary accounts (the Japanese
equivalent to checking accounts for retail customers) at mega-banks decreased from
twohundredths of a percent to a thousandth of a percent. In other words, the interest earned on
depositing 1 million yen for a year declines by 190 yen - from 200 yen to 10 yen. On the
other hand, the extent of the decline in lending rates is much larger. Lending rates for
10-year fixed-rate housing loans provided by mega-banks have declined by 0.25 percentage
point, and the Tokyo Inter-Bank Offered Rate (TIBOR), a benchmark rate for lending to firms,
has also fallen, with the 3-month TIBOR, for example, declining by slightly less than
0.1 percentage point.
While it is true that the interest earned from depositing 1 million yen will be only 10 yen, we
need to consider since when and why deposit interest rates have become so low. The first
time interest rates on deposits in ordinary accounts fell to units of hundredths of a percent
was in 1999, when Japan was falling into deflation. Under deflation, prices decline across the
board and nominal interest rates fall accordingly. This situation persisted in Japan for a
prolonged period. In order to increase deposit interest rates, we have to revitalize the
economy and overcome deflation.
Another concern is that the Bank's negative interest rate policy will have a negative impact
on financial institutions' business, making them more reluctant to lend or leading them to
demand higher lending rates. It is certainly the case that in the prolonged environment of
extremely low interest rates, financial institutions' net interest income from their core
business of taking deposits and making loans has been on a declining trend. Under these
circumstances there is a strong concern that the introduction of a negative interest rate will
make the situation even worse. From a theoretical perspective, financial institutions may not
tolerate the costs imposed by a negative interest rate and instead pass on these costs
through an increase in lending rates. In Europe, where negative interest rate policies were
adopted before Japan, it has been debated whether such policies are having a negative
effect on financial institutions' business and the stability of financial system, and whether
such negative effects might put a limit on negative interest rate policies.
However, the situation in Japan is quite different from that in Europe. First, Japan's financial
institutions have a sufficient capital buffer and remain very sound, since they were not
severely affected by the subprime mortgage problems in the United States and the global
financial crisis. Second, even though their net interest income has fallen, the profits of
financial institutions in Japan have remained high due mainly to lower credit costs reflecting
Japan's economic recovery. In fact, in fiscal 2014, major and regional banks' net income
reached about 3.3 trillion yen - close to a record high. Therefore, it is entirely inconceivable
that in Japan the functioning of financial intermediation will weaken due to strains by negative
interest rates on financial institutions' business. In fact, given the fierce competition in
Japan's lending market, banks are unlikely to increase lending rates to offset the rise in costs
through the negative interest rate policy. Instead, financial institutions should consider why
they cannot make sufficient profit from their core business - taking deposits and making
loans. The reason is deflation. Under deflation, the difference between deposit rates and
short-term money market rates (deposit spreads) as well as the gap between long- and
short-term interest rates have been shrinking. This means that the only way to drastically
improve financial institutions' profit is to revitalize the economy and overcome deflation.
"QQE with a Negative Interest Rate" aims at overcoming deflation completely and achieving
the price stability target of 2 percent. Let me explain how the policy seeks to achieve this.
II. Background to the introduction of "QQE with a Negative Interest Rate"
Why was the policy implemented?
To begin, I would like to touch on the background to the introduction of the negative interest
rate policy. Since the turn of the year, global financial markets have been volatile against the
backdrop of the further decline in crude oil prices and uncertainty such as over future
developments in emerging and commodity-exporting economies, particularly the Chinese
economy (Chart 2). Crude oil prices have dropped to around 30 U.S. dollars. The drop is
positive for Japan, which is an importer of crude oil, but has a negative impact on
commodity-exporting economies including Russia, Brazil, and countries in the Middle East,
creating uncertainty for the global economy.
Furthermore, Chinese stock prices have declined considerably, resuming the slide that
started last summer. However, although the Chinese economy has embarked on a process
of deceleration, it has not deteriorated suddenly. The reasons for the slowdown in the
Chinese economy appear to be the adjustment of excess investment by manufacturers and
restraint in public investment by municipal governments under the tightening of discipline. As
a result, fixed asset investment decelerated but has now leveled off as municipal
governments have resumed with public construction orders from the second half of 2015. In
contrast, private consumption and automobile sales have remained firm, reflecting progress
in the transformation of China's economic structure from one centered on manufacturing to
one centered on nonmanufacturing.
Instead of signaling a sudden deterioration in China's fundamentals, the decline in stock
prices can be seen as the correction of a bubble as well as a reaction to movements in the
exchange rate of the yuan. The yuan is being sold on speculation of a devaluation, resulting
in a decline in China's foreign currency reserves. This has led to instability in markets.
Consequently, stock prices have declined globally and markets have become more
pessimistic, with investors switching to a risk-off mode. In the foreign exchange markets,
demand for the yen, which is regarded as a safe haven currency, has increased, leading to
an appreciation of the yen.
Although markets have become more volatile, Japan's economic fundamentals remain sound
(Chart 3). Japan's economy has improved significantly from three years ago. Corporate
profits are at historically high levels and the unemployment rate is 3.2 percent, which
essentially represents full employment. The year-on-year rate of change in the consumer
price index excluding fresh food and energy has increased from minus 0.8 percent in March
2013 to above 1 percent most recently. Japan's economy is likely to grow moderately and
inflation is likely to increase toward 2 percent. This baseline scenario remains unaffected by
the recent volatility. Nevertheless, in light of their record profits, firms' investment in physical
and human capital has remained rather subdued. Under these circumstances, the volatility in
global markets entails the risk that it may lead to a deterioration in firms' sentiment and a
setback in the conversion of people's deflationary mindset, which had been underway. In
fact, price perceptions by firms have recently deteriorated. Thus, the reason why the Bank
introduced "QQE with a Negative Interest Rate" is that it judged it necessary in order to
preempt the manifestation of these risks and to maintain the momentum toward achieving
the price stability target of 2 percent.
III. Effects of "QQE with a Negative Interest Rate"
What effects will the negative interest rate policy have?
Next, I would like to explain the effects the policy will have. The key aim of this policy is to
drive down real interest rates, which is the main transmission channel of QQE. The fact that
over the past three years Japan's economy has significantly improved and we are no longer
in deflationary situation is proof that a fall in real interest rates has a positive impact on the
economy and inflation.
Let me explain the transmission mechanisms of QQE in more detail. First, QQE raises
inflation expectations through the Bank's strong and clear commitment to achieving the price
stability target of 2 percent at the earliest possible time and through large-scale monetary
easing to underpin the commitment. Second, QQE puts strong downward pressure on
nominal interest rates across the entire yield curve through massive purchases of Japanese
government bonds (JGBs). These two channels result in a decline in real interest rates. The
decline in real interest rates boosts business fixed investment and housing investment
through a decline in interest rates on business and housing loans. In financial markets, QQE
underpins stock prices and helps to weaken the yen, which in turn pushes up corporate
profits, thereby improving employment and wages. The boost in economic activity improves
the output gap - that is, the balance of aggregate supply and demand - which together with
rising inflation expectations, lifts prices. Developments since the introduction of QQE exactly
conform to the anticipated transmission mechanisms.
"QQE with a Negative Interest Rate" represent a framework in which these transmission
channels are further enhanced. The negative interest rate lowers short-term interest rates,
while the massive purchases of long-term JGBs lower long-term yields. These two elements
together exert strong downward pressure on interest rates across the entire yield curve. The
important aspect here is that the effect on the yield curve is stronger when the two elements
are implemented in tandem than when carried out independently. The introduction of the
negative interest rate on current accounts that financial institutions hold at the Bank reduces
their incentive to sell JGBs in exchange for current accounts at the Bank. The reason is that
JGBs with a positive interest rate become more valuable for financial institutions that attach
great importance to interest income. As a result, purchases of long-term JGBs by the Bank
will have stronger effects. Under normal circumstances, when short-term yields are lowered,
long-term interest rates do not decline to the same extent. However, with the Bank's
introduction of the negative interest rate, a large part of the yield curve has declined by about
0.2 percentage points, which is close to the decline in short-term yields, or more (Chart 4).
This means that the extent of the decline in interest rates brought about by the negative
interest rate policy is quite substantial. Going forward, the Bank will assess how the effects of
the decline in interest rates permeate and spread through the real economy.
Doubt over firms' willingness to invest even with a decline in interest rates
Some argue that a decline in real interest rates will not produce the intended effects if firms
are unwilling to borrow and invest. This is possible in the short term, while people are
pessimistic. Over a longer period of time, however, the decline in real interest rates will
surely boost economic activity and inflation through the impact on financial institutions'
behavior and financial markets. In fact, bank lending, which had been declining, has
increased over the past three years at an annual rate of about 2 percent (Chart 5). Stock
prices have risen as well, and the excessive appreciation of the yen has been corrected.
Against the backdrop of such improvement in capital markets, economic growth and the
underlying trend in inflation have increased.
A decline in real interest rates will have no effect only when the expected growth rate, or
natural rate of interest, is at such a low level that the central bank cannot produce a real
interest rate that is lower than that. While this extreme case cannot be ruled out as a
theoretical possibility, I am convinced it does not apply to Japan. Let me point out a couple of
reasons. First, in the past three years, the decline in real interest rates has, as I just
mentioned, produced actual effects. And second, looking at Japan's economy and Japanese
firms, I do not think the situation is as dire as that, given Japan's economic strengths such as
its technological prowess and the skill-level of the labor force. It is implausible that the natural
interest rate is so low that monetary policy would be ineffective.
Does volatility in global financial markets render monetary policy ineffective?
The volatility recently observed in global financial markets certainly makes it more difficult to
clearly see the effects of the negative interest rate policy. Immediately after the introduction
of the negative interest rate policy, stock prices rose, with the Nikkei index adding 800 points
in two days, while the yen fell to 121 yen against the U.S. dollar. Since then, however, the
global decline in stock prices and the appreciation of the yen have continued, triggered by
pessimistic views on the U.S. economy and concern about the stability of the financial
system in Europe. These developments have led to newspaper headlines claiming that the
effects of the negative interest rate policy have been cancelled out.
This is not an accurate assessment. Since the introduction of "QQE with a Negative Interest
Rate," interest rates across the board have clearly declined. This is exactly what we
intended. The decline in yen interest rates and the fact that further monetary easing is
possible - all else being equal - have a positive impact on asset prices. In other words, the
policy works in the direction of raising stock prices and lowering the value of the yen. At the
moment, these effects are being outweighed by the excessive risk aversion among investors
around the globe. However, given that the fundamentals of Japan's economy and Japanese
firms remain strong and that the negative interest rate policy will have powerful effect,
financial markets will turn positive as investor confidence returns.
IV. Adverse effects on financial institutions' earnings and financial markets
Next, I would like to discuss possible costs associated with the negative interest rate policy.
Any policy comes with costs. In other words, there is no such thing as a free lunch. In
deciding on policy action, it is essential to weigh its expected costs against the need for such
policy action and to try to reduce costs wherever possible.
How to mitigate the adverse effect on financial institutions' earnings
Regarding the negative interest rate policy, the potential adverse effects on financial
institutions' earnings and their functioning as financial intermediaries are of utmost
importance. For example, financial institutions might pass on the costs resulting from the
negative interest rate policy to borrowers by raising lending rates for firms and homeowners.
In order to avoid such unintended consequences, the Bank has adopted a multi-tier system
in which current accounts held by financial institutions at the Bank are divided into three
separate tiers. Multi-tier systems have been in place for some time in European countries.
Under the multi-tier system in Japan, a zero interest rate and a positive interest rate apply to
financial institutions' current account balances at the Bank of Japan up to certain thresholds
(Chart 6).
Let me explain how the Bank's three-tier system works. First, the same interest rate as
before - a positive rate of 0.1 percent - is applied to financial institutions' current account
balances already held at the time of the introduction of the negative interest rate policy.
Specifically, such balances are calculated as the average amount outstanding on financial
institutions' current account during 2015 - which are referred to as financial institutions'
"Basic Balances" - minus required reserves. The total of "Basic Balances" minus required
reserves for all financial institutions that have a current account at the Bank is about
210 trillion yen or about 80 percent of the aggregate amount outstanding of financial
institutions' current accounts. Second, a zero interest rate continues to be applied to the
required reserves held by financial institutions subject to the Reserve Requirement System; a
zero interest rate is also applied to the amount of current account balances that corresponds
to the outstanding amount of borrowing from the Bank of Japan through the special facilities
(the Stimulating Bank Lending Facility, the Growth-Supporting Funding Facility, and the
Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the
Great East Japan Earthquake). The sum of these items is called financial institutions' "Macro
Add-on Balance." The sum of such "Macro Add-on Balances" of all financial institutions at the
start of the negative interest rate policy amounted to about 40 trillion yen. And third, financial
institutions' remaining current account balance is called the "Policy-Rate Balance," to which
the negative interest rate is applied. At the start of the negative interest rate policy, the
aggregate amount of "Policy-Rate Balances" for all financial institutions that have a current
account at the Bank was about 10 trillion yen on a net basis.
Since the Bank will continue to purchase JGBs at an annual rate of about 80 trillion yen and
the proceeds of such purchases will be paid into financial institutions' current account at the
Bank, financial institutions' current account balances will increase. Therefore, if the
thresholds remain unchanged, the balances to which the negative interest rate is applied will
increase over time. In light of this, the Bank will raise the amount of current account balances
to which a zero interest rate is applied ("Macro Add-on Balances") at certain intervals - for
example, once every three months - in an incremental manner in order to keep the amount
of current account balances to which a negative interest rate is applied ("Policy-Rate
Balances") more or less unchanged. By doing so, the amount of current account balances on
which financial institutions incur negative interest will be kept to the minimum necessary to
achieve the objectives of the negative interest rate policy.
Given that a negative interest rate applies to only part of financial institutions' current account
balances, you may wonder whether the negative interest rate policy will fully exert its
intended effects. We believe it will. Let me give you an example. If one bank sells JGBs to
another, the proceeds will be transferred into the selling banks' current account with the Bank
of Japan. This transaction will lead to an increase in the selling banks' current account
balance, raising the amount on which the negative interest rate is imposed. This means that
prices in financial markets - such as interest rates, stock prices, and exchange rates - will be
determined under the premise that a negative interest rate is applied to a marginal increase
in financial institutions' current account balances. As the proverb says, seeing is believing. All
you have to do is look at changes in the yield curve. Interest rates have indeed clearly
dropped across all maturities since the introduction of the negative interest rate policy
(Chart 4).
Japan's three-tier system is designed to minimize the direct impact on financial institutions'
earnings while maximizing the positive effects of the negative interest rate policy. The system
works as intended.
Despite the carefully calibrated design of the multi-tier system, the decline in market interest
rates will inevitably have adverse effects on financial institutions' profits. For example, it is
virtually impossible for banks to cut interest rates on their customers' deposits into negative
territory, because they want to maintain their long-term relationships with customers. In
addition, if a negative interest rate is imposed on customers' deposit, this would prompt their
customers to withdraw cash from bank accounts and hoard cash in vaults. In fact, financial
institutions' retail deposit interest rates have never turned negative even in European
countries where the central bank has cut its deposit rate to as low as minus 1 percent. On
the other hand, banks' interest income will decrease reflecting the decline in JGB yields.
Moreover, lending rates on housing and corporate loans will decline to some extent. As a
result, banks' earnings will be negatively affected.
However, it should be noted that monetary easing has been pursued with a view to exerting
positive effects on the economic activities of firms and households - both of which are
financial institutions' customers. These positive effects on the economy and the negative
impact on financial institutions' profits are two sides of the same coin. As mentioned before,
the decline in the yield curve itself is the starting point of the transmission of policy effects.
Reducing the impact of this is not something that can be achieved by changing the design of
the policy.
It is more productive to consider why this adverse interest rate environment, which is
responsible for the decline in financial institutions' profits from their core business - taking
deposits and making loans - has been so protracted. As I mentioned earlier, the
improvements in Japan's economic activity and prices have had a positive impact on
financial institutions' business, for example through the reduction in credit costs. Moreover,
bank lending has been increasing, albeit moderately. However, as financial institutions' profit
margin has not improved, financial institutions' profits remain under strong downward
pressure. The fundamental cause is the protracted deflation in Japan. In an environment of
deflation and low interest rates in which short-term interest rates are close to zero, profits
from deposit spreads disappear, while those from maturity transformation shrink because of
the narrower differential between long- and short-term interest rates due to the flattening of
the yield curve. In addition, since Japanese firms have restrained fixed investment and have
instead hoarded cash and deposits, banks' loan-to-deposit ratios have substantially declined.
Further, reflecting severe competition among banks, lending margins continue to narrow. In
order for Japan's economy to escape from this trap, the economy needs to overcome
deflation completely. If deflation was to return to Japan and the low interest-rate environment
to continue, this would cause more serious problems for banks' profitability. Once deflation is
overcome completely, firms will become more proactive in making investments, which will
lead to an increase in loan demand. Under these circumstances, as short-term interest rates
become positive, banks will be able to profit again from deposit spreads. As the yield curve
become steeper, interest-rate margins will improve due to a larger interest-rate differential
between long- and short-term rates. Therefore, overcoming deflation is essential not only for
the recovery of Japan's economy but also for the full-fledged recovery of financial institutions'
profitability through an improvement in their profit margins.
How to mitigate any adverse effects on financial markets
Another important point that we had to take into consideration when introducing negative
interest rates is the potential adverse effect on the functioning of financial markets. Another
purpose of the three-tier system therefore is to ensure that transactions continue to take
place in the short-term money market. Under the three-tier system, some financial institutions
will hold current account balances to which the negative interest rate is applied, while other
financial institutions will have unused allowances in tiers to which a zero or positive interest
rate is applied. I mentioned earlier that the aggregate amount of policy-rate balances to
which the negative interest rate is applied was initially about 10 trillion yen on a net basis for
all financial institutions that hold a current account at the Bank. In fact, looking at the January
2016 reserve maintenance period, if we sum up the amounts outstanding of policy-rate
balances of financial institutions that have a positive policy-rate balance, the sum was about
20 trillion yen. However, given that some financial institutions have unused allowances in
tiers to which a zero or positive interest rate is applied, these financial institutions can raise
funds from financial institutions that have a positive policy-rate balance at a rate that is still
negative but higher (i.e., less negative) than minus 0.1 percent. These transactions will be
profitable for both sides. If these arbitrage transactions take place in full, the net amount of
negative-rate balances will be about 10 trillion yen. In other words, this suggests that there
are incentives for financial institutions to engage in transactions in the interbank money
market. In Switzerland, money-market transactions are taking place at negative rates. In
these cases, private banks, which have large negative-rate balances, are lenders, and major
banks, which have unused zero interest rate tier allowances, are borrowers. Going forward,
we expect that these arbitrage transactions in the money market will gradually increase in
Japan as well.
Looking at developments in the money market since February 16, when the negative interest
rate started to be applied, although there were no transactions with a negative
uncollateralized overnight call rate on that day, there have been uncollateralized overnight
call transactions with a negative interest rate since February 17, and the weighted average
rate has been negative. Meanwhile, the volume of transactions in call markets decreased
from the previous reserve maintenance period. Nevertheless, I believe that as financial
institutions proceed with updating their computer systems and operations, and as markets
become more accustomed to negative interest rates, transactions in call markets will
increase. In fact, as mentioned, in Switzerland and Denmark, which adopted negative
interest rates earlier, transactions between financial institutions with negative rate balances -
which have become lenders - and those with unused zero or positive interest rate tier
allowances - which have become borrowers - have taken place at negative interest rates.
The volume of money market transactions in the two countries is quite substantial. The Bank
will continue to carefully monitor developments in the money market, including how financial
institutions adjust their computer systems and operations to cope with negative interest rate
transactions.
Concluding remarks
We cannot deny that "QQE with a Negative Interest Rate" has an adverse effect on financial
institutions' earnings. That said, let me reiterate that the aim of the policy is to benefit
households and firms and ultimately to fully overcome deflation. The policy seeks to further
reduce real interest rates and strengthen the effects of QQE, which has proven to be
effective over the past three years. By making full use of "QQE with a Negative Interest
Rate," the Bank will achieve the price stability target of 2 percent at the earliest possible time.
Deflation will not return to Japan. Price stability with 2 percent inflation will definitely be
achieved.
Thank you.
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