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Monday, 19 March, 2001, 11:41 GMT
Q&A: Reviving the Japanese economy

On Monday the Japanese central bank adopted a policy of zero interest rates to help revive the economy. BBC News Online's Steve Schifferes looks at the reasons behind the move.

Why has Japan cut rates to zero?

The move by the Bank of Japan to reduce interest rates to zero is part of an attempt by Japan to revive its economy, which has suffered a long-term recession since the early 1990s.

The main cause of the slump is that Japanese consumers are reluctant to spend money.

After years of growth and "jobs for life", Japanese companies are now laying off workers - and households are saving rather than spending as they fear further cutbacks.

The collapse of "asset prices" in Japan - with shares worth only 25% of their value 10 years ago and property more than halved - has also made consumers cautious.

How do consumers gain?

Consumers and companies will not be able to take out loans with zero interest rates, but they will get rates close to zero.

The reason is that the zero rate refers to the rate banks pay when they borrow the money from the central bank. They then charge customers a rate of interest, to make their profit.

It works the same way as in the UK where base rates are currently 5.75%, but most bank loans have borrowing rates of about 9 or 10%.

Tokyo hopes that its low interest rates make it less attractive to save money, and easier to borrow money for spending.

Companies can also benefit from cheap money, making it easier to fund their investment plans.

And Japan is suffering from deflation - prices of goods are actually falling each year.

That means "real" interest rates, taking into account inflation, are still positive despite the zero nominal rate.

But the danger of deflation is that it makes consumers even more reluctant to spend, and makes it more difficult for companies to get out of debt.

If you know that prices will be 10% lower next year, it is better to wait to buy your car and computer later rather than spend now.

Will it work?

This is not the first time the Bank of Japan has had a zero interest rate policy.

It only abandoned the policy in August, after the Bank said that it believed the economy was recovering and deflation was no longer a threat.

The government has been urging the Bank to reconsider its policy ever since, fearing that the recession was getting worse.

One reason is that the zero interest rate policy makes it easier for the government to borrow money to fund its economic recovery packages.

But the Japanese government has now built up a huge government debt trying to pump-prime the economy with public spending programmes.

However all efforts have so far failed to revive Japanese consumer confidence.

How much further could rates fall?

The Japanese central bank will not be able to reduce official rates below zero.

However, it could loosen monetary policy further by putting more money into the economy, for example by purchasing government bonds. It's the modern equivalent of printing extra money.

And the interest rates on Japanese government bonds - already very low - could also fall further.

But once real deflation takes hold, there are limits to how much monetary policy can deliver - just as in a period of hyper-inflation, psychology begins to take over from economics.

How does it affect the rest of us?

Japan is the world's second largest economy, and if it stays in recession, that will affect growth prospects worldwide - with the biggest impact on Asia.

And fears about the Japanese economy, and the situation of Japanese banks, have affected world stock markets and contributed to last week's dramatic slump in share values.

The lowering of Japanese interest rates could also weaken the Japanese currency, the yen, which has fallen to a two-year low against the dollar.

That could help Japanese companies increase their exports, which are made cheaper by the fall in the value of the currency.

But it could increase protectionist pressures in countries like the US, which import a lot of goods from Japan.

Finally, the Japanese rate cut - and the continuing rate cuts by the US - have encouraged other central banks, for example the Bank of England - to lower rates as well.

Does it help or hurt Japan's banks?

Low interest rates are usually not considered good news for the banking sector, which makes its profits from the "spread" - the difference between the interest rates banks charge on loans, and the rates they have to pay out on deposits.

These spreads are usually higher when rates are high than when they are low, as banks will be reluctant to offer very low savings rates.

But in Japan's case, the main fear is that a number of banks will go under because companies who have borrowed money from them cannot pay it back.

Therefore, if low interest rates help these companies stay solvent, they will ease fears that another banking crisis will sweep through Japan.

Should we all take out yen mortgages now?

Consumers in the UK and elsewhere who hope to benefit from low Japanese interest rates have to be aware of two problems.

First, the cost of converting any mortgage to a foreign currency is substantial.

Secondly, there is a risk that any gains in lower interest rates would be wiped out by changes in the value of the Japanese currency, which has fluctuated by more than 50% against the dollar over the past few years.

Some Western banks attempted to take advantage of the low Japanese interest rates several years ago, borrowing money in Japan and lending it to other Asian businesses.

That turned out to be one of the causes of the Asian financial crisis of 1997-98, when many of these banks faced huge losses after many Asian currencies collapsed and lost up to 80% of their value.

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