Blog post

Big in Japan

What’s at stake: This week saw two important Central Banks’ meetings, whose outcomes could hardly be more different. While the U.S. Federal Reserve le

Publishing date
26 September 2016
Silvia Merler

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Ben Bernanke thinks that the most surprising and interesting part of the BOJ announcement was the decision to target the ten-year JGB yield, for which there is a U.S. precedent (immediately after World War II). Targeting a long-term yield is closely related to quantitative easing, with the difference that pegging a long-term yield essentially amounts to setting a target price rather than a target quantity. In that regard, it is puzzling that the BOJ retained its 80-trillion-yen quantity target for JGB purchases, as one of these two targets is redundant. Bernanke thinks the BOJ was probably concerned that dropping the quantity target would lead market participants to infer (incorrectly) that the Bank was scaling back its program of monetary easing. Over time the redundant quantity target is likely to become softer and to recede in importance, also in terms of the BOJ’s communication.

But is the BOJ’s switch to a long-term rate peg a good idea? Bernanke warns that pegging a long-term rate carries risks: notably, in defending a peg, a central bank gives up control over the size of its balance sheet, especially if the peg is seen as non-credible. Bernanke argues that in the Japanese context these risks are probably manageable. BOJ already owns a substantial portion of outstanding JGBs, and those still in private hands are not very price-sensitive: as a result, BOJ may be able to meet its yield target by buying considerably less than 80 trillion yen a year. Since constraints on the availability of JGBs were seen in the past as limiting the BOJ’s ability to maintain its easing policies for a long period, then the new framework may be actually seen as more sustainable.

Tomoya Masanao, writing on PIMCO’s blog, says that the policy “regime shift” from base-money targeting to yield-curve targeting was not exactly expected by market. He sees three reasons for this change. First, BOJ has hit the limit on how low and flat the yield curve should be from a policy effectiveness point of view. Excessive flattening of the yield curve starts to be more harmful than helpful for the economy, so the neutral yield curve should be steeper, and the bank should be able to reduce the long-end JGB purchase amount and “taper” the QE without damaging the economy. Second, BOJ is also inching closer to a practical limit on how many more JGBs it can buy, considering the fact that banks and insurers will not sell the JGBs they need to hold for collateral and liability-matching purposes. Third and related, BOJ’s war against deflation will be a very long one and hence the easing program will need longevity.

Masanao however is sceptical on whether yield-curve targeting will help the BOJ achieve its 2% inflation target, as the expected transmission mechanism of policy will be the same under the new regime. Stealth tapering of the QE should help delay hitting the practical limit on the QE operation, but it still runs the risk of being viewed negatively in the markets. The BOJ’s decision is evidence of its policy exhaustion. The Bank will remain super-accommodative but will no longer be able to take the lead: it is sneaking into the back seat.

David Beckworth at Macro and Other Market Musings wonders whether the Bank of Japan is doing “Monetary Mastery or Quantitative Quagmire”. He is rather hopeless in the effectiveness of the policy changes, for two main reasons. First, the BoJ is pegging the 10-year yield on government bonds at a level it would be at anyways: the market-clearing or natural interest rate that is based on fundamentals has been falling for some time and is already very low. The BoJ's new long-term interest rate target simply is a recognition of this fact. Second, there is a serious credibility issue when it comes to the expansion of the Japan's monetary base: the monetary base has triplicated in size but population is aging and depends increasingly on fixed income, so there is no political economy support for the radical change in the price level that should be expected if this expansion was really to be considered permanent.

Scott Sumner at the Money Illusion blog argues that the BOJ decision shows the Bank is still willing to experiment, and makes an analogy to when the Fed first engaged in forward guidance. The BOJ’s 10-year bond yield cap is ambiguous, but perhaps the BOJ’s next step will be to switch to price level target, in order to make the size of the inflation overshoot more concrete.  Or maybe instead of capping 10-year bond yields, they’ll peg something more unambiguous, such as the yen against a basket of currencies. If that’s too controversial (and it probably is) then they could peg the yen against a CPI futures contract. The danger remains that this specific move won’t work, and the backlash will prevent the BOJ of moving further down the road in the future.

Martin Sandbu at the FT Free Lunch blog argues that the policy shift should not be understated because it removes the self-imposed shackles on further loosening that have held back not just the BoJ but many other central banks. Fixing long rates is not just a substitute but a superior alternative to QE, because long-rate targeting should be successful without huge balance sheet expansion, if credible. That would avoid the main objections that come with large asset purchases, i.e. the political grumble about central banks becoming unduly large market participants, and the economic grouse that this creates too much bubbly liquidity. Sandbu argues that the BOJ should see the slope and the overall level of the yield curve as two separate instruments: keeping the long rate at zero, it should now steepen the yield curve — which entails markedly more negative short rates. Overall, he is of the idea that BoJ has again made a pioneering move, which other central banks should take a close look at. Check out also David Keohane’s posts at FT Alphaville for a summary of market views on the move.

Miles Kimball, at the Confessions of a Supply Side Liberal, is not impressed by a target of zero for 10-year Japanese government bonds as stimulative measure, when they have been trading at negative rates. Fortunately - he argues - this is probably just a sign that the Bank of Japan is continuing to search for new tools. In particular, one of the most powerful tools the Bank of Japan has not yet tried is a negative paper currency interest rate through a gradually increasing discount on paper currency obtained from the cash window of the Bank of Japan (and a corresponding gradually increasing discount in what is credited to a bank’s reserve account when paper currency is deposited). An important complementary policy would be to make negative rates more acceptable politically: a shift in the details of the interest on reserves formula to explicitly link the amount of funds on which banks can earn an above-market interest rate to their provision of zero rates to small household accounts. Finally, the ability of banks to get an above-market rate on a portion of their reserves could be tied to their passing along the discount on paper currency to their customers when they withdraw paper currency. Kimball argues that this combination would give the BOJ the firepower it needs to achieve its goals.

George Magnus looks in tandem at the Fed and BOJ, reaching the conclusion that there are no easy solutions. After the Banks’ meetings this week, it is clear their positions could not be more different. While the BOJ is struggling to ease monetary policy, the Fed is struggling to reduce monetary accommodation. The BOJ does not have to contend with the political machinations surrounding the Fed, its job is no easier. The monetary base has risen threefold since 2012 and yet, Japan still has not distanced itself from deflation. Magnus agrees with Bernanke that BOJ’s targeting is unclear: the BOJ now has six targets (a price and a quantity target for JGBs, negative interest rates at -0.1%, the Japanese yen as a transmission mechanism to inflation, 2% or more inflation, and a steeper yield curve), which is very confusing. A bigger problem comes from fundamentals: unless the BOJ and/or the government can engineer a sustainable rise in real GDP growth and inflation, investors will simply buy longer-dated bonds again, and the yield curve will get flatter - quite the opposite of what the BOJ intends.

Magnus says it would be far simpler, and more transparent if the authorities in Japan were to admit that unusual monetary policies, as currently constituted, had reached the limit of their effectiveness given the demographic and structural conditions that now prevail. This should then lead to a discussion as to how the BOJ and the government might work together to help policy gain greater traction, essentially debate the fiscal nature of what people call "helicopter money." In effect, the BOJ is already doing a form of monetary financing by keeping the 10-year JGB yield at zero indefinitely, and so we might argue that the authorities should go all the way and do monetary financing properly, openly, and with constraints that should be spelled out.



About the authors

  • Silvia Merler

    Silvia Merler, an Italian citizen, is the Head of ESG and Policy Research at Algebris Investments.

    She joined Bruegel as Affiliate Fellow at Bruegel in August 2013. Her main research interests include international macro and financial economics, central banking and EU institutions and policy making.

    Before joining Bruegel, she worked as Economic Analyst in DG Economic and Financial Affairs of the European Commission (ECFIN). There she focused on macro-financial stability as well as financial assistance and stability mechanisms, in particular on the European Stability Mechanism (ESM), providing supportive analysis for the policy negotiations.


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