Ben Bernanke made a splash in the late 1990s criticising the Bank of Japan. He argued that the Japanese situation (at that stage a decade of stagnation) was one of ‘self induced paralysis’, and that there were options available to the BoJ that would end deflation and support growth.
Since making those comments, Bernanke has found that actually taking his former self’s advice is more difficult — notwithstanding, there is a strong sense in which the arguments he made at that time have been a good guide to the actions he has subsequently taken (the WSJ’s Hilsenrath was writing about Bernanke ’99 in 2010, prior to QE2).
Yesterday, the BoJ’s new Governor Kuroda followed Bernanke’s lead, and surprised markets with open-ended QE. This caused an immediate drop in the foreign exchange value of the JPY and caused the 10yr JGB yield to decline by the largest amount in nearly a decade, hitting an all-time low of 0.425%
My sense is that Bernanke’s demonstration that a central bank retains powerful tools once the zero-lower-bound is hit has motivated the BoJ. Once it was clear that ‘good’ options were available, it became inevitable that politicians would push central banks toward them.
So what did the BoJ actually do (their statement is here)?
1/ The BoJ set a goal of ‘about 2yrs’ for achieving 2%y/y inflation. The 2% target is not new (though it is recent), but this is the most committed they have been to a date.
2/ The BoJ announced a ‘new phase’ of monetary easing — both in terms of ‘quantity and quality’. As part of this, the operational target has been moved from the overnight call rate to the monetary base. The target is now a Y60-Y70tn increase in the money base each year.
For those that are rusty on Money and Banking jargon:
Monetary base = Banknotes in Circulation + Coins in Circulation + Current Account Balances
In Japan, the largest part of the monetary base is currently notes (~62%), with current account balances that Japanese Banks hold at the Bank of Japan the next largest part (~35%). A policy of Y60tn to Y70tn annual increase in base money will mean a substantial increase in the present ~Y47tn of current account balances held at the BoJ (the BoJ’s base reports are here) … likely of about Y60tn to Y70tn per annum.
At over Y47tn already, it seems implausible that Japanese banks are currently reserve constrained in their lending — more likely, they suffer from a lack of good (risk adjusted) lending opportunities. Thus, targeting an increase in base money is unlikely to have much direct impact on the economy. Fortunately, the policy that’s been announced is sufficiently large that we can be reasonably sure that it will move prices in many markets, and these consequences (or ‘distortions’) ought to have medium run impacts on broad macro variables (you can see it in JGBs, the JPY and equities yesterday).
I do, however, think it is a mistake to focus too much on the money base (or Japanese Bank reserve balances). These are a necessary consequence of the BoJ’s open market operations (balance sheets must balance: see my prior note) — not the means by which they will impact the economy. Buying Y60tn per year of assets must make these balances rise — it doesn’t tell us if the policy is (or isn’t) working.
3/ What will they buy and how much? JGBs, ETFs and J-REITS with no upper limit. The targets are now all flow based (Yen per year).
A/ Y50tn per year of JGBs. In addition, they will start buying across the curve (all the way out to 40yrs) and will lengthen their portfolio from ~3yrs to ~7yrs.
B/ Y1tn per year of ETFs and Y30bn per year of J-REITS. The CP and corporate bonds programmes will continue until they reach their targets of 2.2 trillion yen and 3.2 trillion yen — but will not be extended.
My view is that these policies work better the more risk the central bank takes. The more risk, the better the payoff per Yen. The most effective policy would be to buy equities — however it’s hard to avoid deleterious corruption once one starts directly allocating financing in that way.
As an early step, buying long-term JGBs, equity ETFs and J-REITs seems promising.
The next step is convincing Japanese investors (who have thus far been selling foreign assets and buying JPY, to lock in their FX gain) that the BoJ is serious about sticking to these policies. If this is achieved, we may see capital flow out of Japan, which would encourage a further leg down in the nominal value of the JPY.
Aussie Governments at ~3.5% must seem pretty attractive to Japanese investors who are contemplating 40bps for 10yr JGBs.