Nontraditional Financial Policies

This study examines how nontraditional financial policies were implemented in Japan from the late 1990s to the early 2000s by looking at the differences between the zero interest rate policy and quantitative easing policy. During this time, the Bank of Japan adopted an unprecedented ultra-low interest rate policy. Orthodox financial policies had become ineffective because of the liquidity trap. However, under increasing instability in the financial markets, this radical financial policy proved to be somewhat effective as a credit-easing measure. In this analysis, I focus on the fact that a difference between the high and low daytime call rates (the spread) emerges as a reflection of the risk premium, and I examine how that spread differed during the zero interest rate period and the quantitative easing period. Not only did the ultra-low interest rate policy cause the short-term interest target rate to approach 0 percent, but it was also somewhat effective at reducing the size of the spread in the call market. However, the quantitative easing policy caused further significant reductions in the call rate spread, virtually removing the risk premium from call market transactions. Thus, it is very possible that Japan's radical financial policies, including its quantitative easing measures, reduced liquidity risk and credit risk in the market, and ultimately contributed to the performance of the overall economy by easing access to credit. At the same time, however, radical financial policies create a moral hazard for financial institutions, which are supposed to be weeded out through market mechanisms. During the period of quantitative easing, the institutions that added the most to their excess reserves as a ratio of their total funds were foreign banks, as they were able to procure yen funds under the highly advantageous condition of negative interest. In reality, financial institutions on the verge of bankruptcy also increased their liquidity. On the other hand, the Lombard-style lending that was implemented in the early years of the 2000s generally fell out of use once the quantitative easing policy was strengthened. These super-loose monetary policies, in spite of their side effects, seem to have played an important role as macroprudential policies.