Japan's Experience with Zero Interest Rates

Abstract

I WOULD LIKE TO START by congratulating the organizers of this conference for having been very successfully forward looking. Zero interest rates have become a reality if in a small part of the world. I regret that I have not been forward looking enough. By first accepting the invitation to attend this conference and then having driven the rate down to zero, I have put myself in a very difficult position. Anyway, let me start by spending a few moments discussing what we have been doing since last year. When I joined the board in April 1998 the overnight call rate was already slightly below 50 basis points, not a good time to join a central bank. Since then we have cut it down successively to zero, more precisely 1 basis point for lenders and 2 basis points or above for borrowers. The overnight rate came down to these minimum levels toward the end of March 1999. This was already a very extreme monetary policy stance. But we achieved this by using a traditional tool, that is, the overnight rate. I must say that we needed a lot of courage to go to the zero rate. In April 1999, we went further in a fairly nontraditional way. That is, our governor announced that we would stick to the zero rate policy until deflationary concerns are over. This commitment, we think, delivers something very close to what inflation targeting or quantity targeting might offer, to the extent that you believe that monetary policy works through interest rates. Or, we could say that this has been like our writing a put option on short-term assets. Yet another way of explaining our position could be the following: by the commitment to maintain the zero rate for quite some time to come we have tried to minimize uncertainties about future short rates, thereby decreasing the option value of long-term bonds, hence putting negative pressure on long-term interest rates. With this announcement market interest rates came down sharply again. As of early October, three-month and one-year Treasury bills were trading at 4.5 and 3.5 basis points, respectively. Do we need any further action? Obviously, it depends on where you think the economy is. After growing at negative rates for five consecutive quarters, real GDP grew at surprisingly high rates in the first two quarters of this year. We were worried that this turnaround could be short-lived because the stimulus from fiscal policy was expected to peter out later this year. However, the news we have been getting for the