The Yen Also Falls: To Negative Nominal Rates?

♠ Posted by Emmanuel in , at 12/17/2012 07:17:00 AM
Everything is less than zero - Elvis Costello

I am constantly befuddled by foreign exchange markets since they tend to display even more "irrational" behaviour than stock markets. Witness Japan and its currency. Beginning 1999 or so, Japan has conducted aggressive monetary easing via its zero-interest rate policy (ZIRP) that entails [duh] near-zero nominal interest rates. However, this and quantitative easing (QE) have done little to pull Japan out of its funk since the bubble burst in 1990. I of course think there are lessons to be learned here for Westerners who do the same Stupid Monetary Tricks, but others would say that their situations are different.

No matter; after being the almighty yen for the past several years, we get news that the yen is (slightly) weakening due to the (actually quite conservative and traditionally dominant) Liberal Democratic Party beating the (once upstart but now quite entrenched and equally staid) Democratic Party of Japan in parliamentary elections. News of an LDP victory has sent the yen tumbling--or at least what passes for it in this day and age of mild rather than wild forex swings in Japan:
The yen slumped to its lowest in over a year-and-a-half against the U.S. dollar on Monday as part of a broad skid after Japan's conservative Liberal Democratic Party, which is committed to aggressive monetary easing, won a landslide victory. The LDP surged back to power in Sunday's election, giving ex-Prime Minister Shinzo Abe another chance to take the helm. The LDP and its ally the New Komeito party secured the two thirds majority needed to overrule parliament's upper house, meaning the new government has a greater chance of pushing though its policies.
The LDP being a traditional practitioner of patronage politics, their priorities lie in American-style "shovel ready" projects. It's somewhat ironic; they taught the Yanks all this ZIRP and QE tomfoolery which they are continuing with anyway, and in turn they are imbibing construction-as-stimulus:
The Bank of Japan meets later this week and most analysts expect the central bank will ease policy further. It will most likely increase its asset-buying and lending programme, currently at 91 trillion yen, by another 5-10 trillion yen, sources have said. Abe, who quit as premier in 2007 citing ill health, has called for "unlimited" monetary easing and big spending on public works to rescue the economy from its fourth recession since 2000.
I have always been a connoisseur of sorts of Japanese economic policy. Accustomed to being meek and mild worker ants in the postwar period, they still display their banzai and kamikaze streaks in a few areas alike macroeconomics. How did they manage to run up a public debt that is 200% of GDP which is set to rise even more sharply with the LDP that's responsible for a lot of it? Honestly, I think that the fiscal levers are well and truly overdone. What's there left? Consider once more the "zero-bound" problem:
In spring 1999, ZIRP was introduced but it was constrained by the so-called zero bound problem. Therefore, worsening deflation meant the real interest rate would rise, aggravating recession and hence deflation.   
What the heck else can Japan do? Having "pioneered" the modern implementation of ZIRP, maybe they can try NIRP--negative interest rate policy. That's right; they should target rates at which they punish you for keeping money in a bank. Certainly even such a palliative won't work--those thin tatami mats they roll away during the day won't hold as many squillion yen as king-sized beds those portly Yanks have--but it may be worth a try as implied by yen weakening as of late. At the very least there will be amusing stories of folks hoarding cash.

Desperate times call for desperate measures. Bring on the NIRP! It's the ultimate weapon--unthinkable, even--in international currency war (and more specifically Japan's two-decade-long battle with deflation).

Screw M2, if you know what I mean.