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Japan's Lost Decade — 1989 to 2006

Japan's Zero Rates and Quantitative Easing

Explain what the Bank of Japan's zero interest rate policy and quantitative easing were, how they differed, what the Bank promised with each, and the reason it gave for ending the zero rate in August 2000.

Before you start

What you'll be able to answer

  1. What was the zero interest rate policy, and why did the Bank of Japan say it ended it in August 2000?
  2. What was quantitative easing, and how long did the Bank of Japan promise to keep it?
  3. How did the zero interest rate policy and quantitative easing differ?

Where this sits

Japan's Lost Decade — 1989 to 2006 · this module is lit

  1. Dec 1989Share prices in Japan peak
  2. Aug 1990The Bank of Japan's last rise in its discount rate, the interest rate at which it lent to banks
  3. Aug 1992The government announces the first of six spending packages up to 1995
  4. 1995-96The first direct use of taxpayers' money against financial instability covers losses at failed housing-loan companies, the jusen
  5. 1 Apr 1997The consumption tax rate, a tax on what people buy, is raised
  6. Nov 1997Sanyo Securities, Hokkaido Takushoku Bank and Yamaichi Securities fail
  7. Oct-Dec 1998Japan's parliament, the Diet, makes more public money available to deal with banks' bad loans, and the state takes over the Long-Term Credit Bank and Nippon Credit Bank
  8. Feb 1999The Bank of Japan begins its zero interest rate policy, pushing its overnight rate as low as possible
  9. Mar 1999Public capital, new capital paid for by the state, is put into the major banks
  10. Mar 2001The Bank of Japan begins quantitative easing, a target for the money banks keep in their accounts with it
  11. Oct 2002The Financial Services Agency, the banking regulator, launches its programme to cut bad loans
  12. Mar 2006The Bank of Japan ends quantitative easing

By 1999 the Bank of Japan had little room left to cut its rate

Early in 1999 Japan's economy was still weak and its prices were falling. The Bank of Japan, Japan's central bank, worked through the overnight rate, the rate banks charge each other for one-day loans. Since September 1998 that rate had been about a quarter of one per cent, so there was little room left to cut. Long-term interest rates had risen, which made borrowing for longer periods dearer, and share prices were weak.

Take a guess

Banks borrow from each other overnight when they run short of money. Suppose the central bank gives banks more money than they need. What do you expect to happen to the overnight rate?

In February 1999 the Bank pushed its overnight rate as low as possible

On 12 February 1999 the Bank of Japan began pushing its overnight rate as low as possible. It did this by supplying banks with more money than they needed. Banks with spare money will lend it to other banks for less, so the rate falls. To avoid sharp swings in the market, the Bank aimed at first for around 0.15 per cent, then lower. The rate was virtually zero by March.

This was what the Bank of Japan calls the world's first zero interest rate policy. Its aim, the Bank said, was to give the economy as much support as it could and to keep the pressure for falling prices from growing. Falling prices make a debt fixed in yen harder to repay, so they hurt firms that owe money.

In April 1999 the Bank promised to keep the rate at zero

Two months later, in April 1999, the Bank of Japan promised to keep the rate there until the fear of falling prices had passed. At the time this was called the policy duration effect. A promise like it is now called forward guidance.

The promise was meant to work on loans for longer periods. A lender asked to lend for several years thinks about where the overnight rate will be over that time. If it expects the rate to stay at zero for longer, it can charge less. A promise to hold the rate at zero until inflation, the rate at which prices rise, turned positive gave more support than a zero rate on its own, Bank of Japan economists wrote in 2005, because it lowered the rates lenders expected in future.