Question

From the mid 1990’s up to mid 2000’s, Japan’s short-term interest rates clearly have had periods during which they were near or equal to zero. Is the fact that the yen interest rates shown never drop below zero a coincidence, or can you think of some reason why nominal interest rates might be prevented by market forces from going below zero?

0.0 15.0 18.0 120 - 3.0 6.0 9. 01 21.0 8/31/1978 + 8/31/1980 8/31/1982 Yen rate 8/31/1984 8/31/1986 8/31/1988 Dollar rate 8/31/1990 (Percent per Year) Interest Rate on Dollar and Yen Deposits, 1978-2004 8/31/1992 8/31/1994 8/31/1996-1 8/31/1998 8/31/2000 + 8/31/2002 8/31/2004

Answer 1

Nominal interest rates are the rates of interest that a given borrower pays including the rate of inflation. This can be mathematically represented by:

Nominal Interest Rate: Real Interest Rate + Expected Inflation.

An interest on deposits is paid by the bank to the depositors for holding an individual's money. In other words, consider deposits to be a financial instrument on which the depositor gets a rate of return, and this rate of return is the incentive to an individual to deposit their money with the bank.

In simple terms, an interest rate on deposits is not likely to go below the zero mark because that would entail the depositor paying money to the banks to hold their money (excess cash reserves). In such a scenario, there would be no economic pragmatism to hold deposits as financial assets as holding cash with a zero rate of return would be more practical than paying a fee to deposit money. Therefore, the rational essence of market forces would prevent the interest from dropping below zero mark.

However, an imposition of a negative rate policy can be seen from the viewpoint of advocating expansionary measures, as it penalizes banks to hold cash, and promotes lending. The zero-interest-rate-policy was prevalent during the Lost Decade as a measure to revitalize the economy, after its stagflation, and the development of a deflation in early 1990s.