Assume that there is change in the expected exchange rate Ja

Japan\'s short-term interest rates have had periods during which they are near or equal to zero. Is the fact that the yen interest rates never drop below zero a coincidence, or can you think of some reason why interest rates might be bounded below by zero?

Solution

A country never drops its interest rates below zero because in no way it is profitable to the economy. Nominal interest rates in general can never fall below zero. The reason being if they fall below zero, lenders just won\'t invest their money. They won\'t be left with any incentive to invest their money. They would rather keep it in their pockets. When nominal interest rates are negative, their money would provide two advantages to them: Higher liquidity i.e. they can quickly get their money whenever they need it AND it also yields higher nominal rate of return (zero) when compared to deposits. That\'s the reason why the yen interest rates in japan has never dropped below zero.