Bank of Japan Modifies Policy but Characterizes such as “Furthr Effective and Sustainable Monetary Easing”

March 19, 2021

Long before the pandemic, the Bank of Japan had significantly modified the framework of its highly accommodative monetary easing in September 2016 and renamed the program Quantitative and Qualitative Easing with Yield Curve Control. Policy focus was shifted away from money growth to a more targeted effort to ensure a positive output gap, flatten the whole yield curve to a negative short-term rate and zero percent over the rest, and greater utilization of forward guidance to engineer a rise in expected inflation. A key component of the new framework was the goal to not stop easing until inflation had in fact risen above the 2.0% target for a while. Later in July 2018, the BOJ introduced some flexibility in the administration of a zero percent target on the 10-year JGB yield. The combination of negative to very low interest rates, a positive output gap, relentless asset purchases, and several programs to encourage lending has had two major failings, nonetheless: the scourge of deflation hasn’t been eradicated, and prolonged administration of the policy has sapped the profitability of financial institutions and thereby eroded investor confidence that it can be sustained.

After meeting these past two days and amid rumors that monetary officials were looking for a face-saving way to move away from its “for as long as it takes” commitment with honor. Sure enough, the rumors proved not to be baseless, as a number of modifications were introduced in today’s rather lengthy statement. The range around the zero percent 10-year yield target was widened to +/- 25 basis points and will be applied asymmetrically whereby moves above the corridor will be rigidly resisted but not dips below it. Number 2, a new interest rate scheme to promote lending was established. Third, the purchases of ETFs and J-REITs will be done more subjectively as deemed necessary rather than automatically on a preordained level regardless of market conditions.

The latest economic assessment by the Bank of Japan concedes that a severed covid-induced situation persists even as activity in areas has picked up. Negative core inflation is expected to continue for a while. Such will eventually turn positive as the pandemic recedes, but the upturn will be gradual and fragile.

As one might expect, Governor Kuroda devoted his press conference to spinning today’s modifications as mere tweaks and in no way a sign that the commitment to an ultra-easy policy for as long as necessary to restore actual and expected core inflation of 2.0%. One can empathize with the frustration of BOJ officials. The overnight interest rate target hasn’t been above 0.5% since September 1995. There is a lesson in Japan’s experience for other countries and for market participants wanting and believing that central banks must head off even a short-term bout of above-target inflation. Monetary policymakers always have the tools if they share the will to reverse excessive inflation. Paul Volcker showed that when U.S. inflation spiked into double digits four decades ago. Central banks do not have sufficient tools to reverse an entrenched deflation (a general decline of prices), which is an infinitely more difficult task than slowing inflation.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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