Decline of oil prices and the negative interest rate policy in Japan

In April 2013, the Bank of Japan (BOJ) introduced an inflation target of 2% with the aim of overcoming deflation and achieving sustainable economic growth. But due to lower international oil prices it was unable to achieve this target and was forced to take further measures. Hence, in February 2016, the BOJ adopted a negative interest rate policy by massively increasing the money supply through the purchase of long-term Japanese government bonds (JGB). The BOJ had previously only purchased short-term government bonds, a policy that flattened the yield curve of JGBs. On the one hand, banks reduced the number of government bonds they purchased because short-term bond yields had become negative. The interest rates of long-term government bond up to 15 years even became negative. On the other hand, bank loans to corporates did not increase, due to Japanese economy’s vertical investment–saving (IS) curve. The purpose of this paper is to show that the monetary policy through implementation of the zero interest rate and more recently through the negative interest rate could not help the Japanese economy to recover from the long-lasting recession and these are not the remedy. It is of key importance to make the IS curve downward rather than vertical. That means the rate of return on investment must be positive and companies must be willing to invest even if interest rates are set too low. Japan’s long-term recession is due to structural problems that cannot be solved by its current monetary policy. The paper also explains why the BOJ has to reduce its 2% inflation target in the present low oil price era.