Lower Interest Rates Won't Spur Japan's Economy

February 14, 2001

Japan's central bank recently lowered the discount rate, the rate at which it lends money to banks, to 0.35 percent from 0.5 percent. The U.S. Federal Reserve Board has been cutting interest rates in order to spur economic growth -- but with interest rates less than one-tenth as high as in the U.S., Japan's economy is growing little, if at all.

So why doesn't the magic of lower interest rates work in Japan?

  • Because funding in the country isn't much affected by the cost of money, says an editorial in the Far Eastern Economic Review -- interest rates have been as low as zero with little effect.
  • Banks are plagued with bad debt, and making more loans at such low rates isn't likely to make them more money (while exposing them to some risk of default).
  • Thus, cheaper money is a disincentive to lend.

When Japan's so-called bubble economy burst a decade ago, instead of allowing the market to squeeze out failing companies, as the U.S. did during the savings and loan crisis, Tokyo tried to spend its way out of trouble. It propped up companies and banks that should have gone under, and the high national debt made it difficult for worthy companies to get financing.

Observers say Japan needs economic reform and to cut taxes (such as the high national sales tax). Monetary policy isn't going to help growth much.

Source: Editorial, "Interest Policy," Far Eastern Economic Review, February 22, 2001.

 

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