Last week, I wrote on the ECB’s meeting and the case for easing credit conditions in the periphery (a recommendation that they didn’t heed, though pressure to act is building). I ignored the upcoming Bank of Japan (BoJ) meeting. My wife’s comment the next day summed it up well: “you blogged on the wrong central bank.”
For those that don’t follow central banking closely, it’s worth a moment of reflection on why what the BoJ did last week was so important.
In his first meeting as central bank governor, Mr. Kuroda produced a package that easily meets an economic “Powell Doctrine” test–having exhausted all the other options, it brings overwhelming force to bear in order to change expectations for financial conditions, inflation, and growth in Japan.
- The Bank adopted a price stability target of 2 percent for the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years.
- To get there, it targeted a doubling of the monetary base (the previous target was the overnight interest rate), an annual increase of 60 to 70 trillion yen.
- It will double its holdings of Japanese government bonds (JGBs) as well as exchange-traded funds (ETFs) in two years (a net purchase of around ¥5 trillion per month), and more than double the average remaining maturity of JGB purchases. The decision to purchase bonds of longer maturity gets the BoJ more bang for the yen then if they had stuck to the old practice of focusing on short-duration bonds. Scaled for the economy, this is not that much different from what the Fed has done and twice the current pace of Fed purchases.
- The Bank is committed to continue with its quantitative monetary easing as long as necessary to achieve these targets.
At some level, this should look familiar as it in substance mirrors the non-conventional easing strategy followed by the Fed in recent years in its combination of purchases of longer-duration assets with a commitment to maintain such policies for longer than markets might otherwise expect. In the presence of a liquidity trap, the key to making quantitative purchases effective is to credibly promise to raise inflation, and this effort goes in that direction. Some also are comparing the action to Paul Volcker’s anti-inflation policy of 1979. Like that experiment, the Bank of Japan recognizes the uncertainty in how the experiment will play out and, by shifting to a monetary base, signals its willingness to accept whatever rates are needed to reach their quantitative targets.
It’s a major break with past policy, and that is the central point: the new policy represents a fundamental shift in the paradigm that has guided Japan monetary policy for the last 25+ years. Since the bubble of the late 1980s, economists have criticized the BoJ policy as too tight, too tentative, and too willing to tighten prematurely when green shoots of recovery appeared. BoJ staff repeatedly justified their policies with the argument that deflation in Japan was structural, a function of demographics and the special characteristics of Japan’s economy, and thus outside the ability of the monetary policy to reverse. Last week’s package of measures, adopted unanimously (some of the measures were rejected by an 8 to 1 vote last month), represents a repudiation of that view.
The effect of the announcement on markets–a sharp decline in the yen from below 93 per dollar earlier this month to 98.9 currently, an increase in the Nikkei, and strength in a range of other currencies whose markets are expected to benefit from Japanese capital outflows–was dramatic and is likely to continue to percolate this week. The IMF and key central bankers saluted the action, while others expressed concern about the yen’s depreciation. Whether this is the green light to “currency wars” and capital controls that bubbled to the surface at last months’ G-20 meeting remains to be seen. What the Bank of Japan did last week is an important moment. It also puts in sharp contrast the inadequacy of the ECB’s approach to ending deflation pressures in Europe.