Japan’s monetary policy might be the future of monetary policy around the world. The late 80s were a time of boom where buyers found themselves paying the highest prices for goods and commodities. The following decade would see Japan’s economy decline substantially, giving rise to the name the ‘Lost Decade’. 1990s was a reality check for Japan when the stock market fell drastically, commercial real estate prices. Banks and companies started using all of their money to pay down debt and cover their losses instead of using that money to invest in new things. Some say that the economic damage was greater than that of the Great Depression.

Deflation, or falling prices is far more dangerous than its counterpart inflation. When prices start falling people stop buying things. This is because people want to wait for prices to fall further. They start hoarding money. Eventually the demand falls, causing the production to fall. Workers are laid off which causes the demand to fall further. This forms a deflationary cycle that spirals out of control if no intervention takes place. Its really damaging for an economy.

By 2013 the country was getting desperate. They really needed to do something to get economy going again. Economists believe a a low level of inflation is healthy. It encourages people to spend.

First it made sure that people believe that prices would rise. A sort of psychological approach. Haruhiko Kuroda, the Governor of BOJ, has been the brain behind this aggressive policy. He assumed office in 2013 and has since then worked to bring Japan out of this situation.

Next it flooded the system with money. Bank of Japan bought a lot of bonds, stocks and real estate funds. The scale of purchases was a lot bigger. It just started pumping a lot of money.

The third and the most interesting step was to introduce negative short term interest rates. Central Bank provides interest to other banks for parking their funds with it.
When the country wants to spark inflation, it lowers short term interest rates. That makes it cheaper for banks and companies to advance loans or invest. Japan’s short term interest rates had been at or close to zero for a long time so negative interest rates was the way forward. So now Banks have to pay money to central banks for depositing money. An unconventional idea indeed. This has all been done to force banks to lend and invest more.

So far Japan has managed to avoid deflation and maintained an almost 1% inflation rate. All the central banks of the world are watching closely.