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Irresponsibly responsible

11 October 2012 By Andy Mukherjee

The Bank of Japan has a conundrum: how to make a credible commitment to recklessly printing more money. The central bank wrote the primer on unconventional monetary policy a decade ago when it pioneered quantitative easing. But as other central banks have embraced loose money, the BOJ has become an increasingly forlorn figure in a crowded rogues’ gallery.

The U.S. Federal Reserve has set the tempo by promising near-zero interest rates until mid-2015. It has also made an open-ended commitment to buying mortgage bonds at the rate of $40 billion a month until the labour market shows sustained improvement. Meanwhile, the European Central Bank has vowed to buy short-term government bonds of all euro zone countries that officially seek help.

In such a merry season of central bank liberation, the BOJ is stuck with the straitjacket of a predefined, 80 trillion yen ($1 trillion) asset-purchase programme that does expand from time to time – but only when the economy threatens to slip further into its deflationary funk. The result is a Sony Walkman pretending to be an iPhone 5; since the second quarter of 2008, the Bank of Japan has increased its supply of currency and bank reserves by 42 percent. The Fed has more than tripled its monetary base over the same period.

Even the target of the BOJ’s limited asset-buying plan is problematic. The most recent monetary easing plan, announced on Sept. 19, added 10 trillion yen in treasury bills and government bonds to the monetary authority’s shopping list. That’s inadequate for two reasons. First, the BOJ will be making these purchases next year, when they will no longer have any shock value. Second, Japanese banks will be reluctant to part with a three-year government bond that pays a precious 1.4 percent annual coupon if the most likely alternative is to deposit the proceeds with the central bank at a rate of 0.1 percent.

One option is for the BOJ to offer a more generous price – something the central bank has allowed itself to do by scrapping a limit on the minimum yield (and therefore maximum price) it could pay at auctions. But even a negative yield isn’t novel any more. Mildly negative nominal interest rates have already appeared in Denmark, Switzerland and Germany, and deeply negative ones will be impossible as long as currency – a competing security that pays zero interest – isn’t outlawed.

So what will shock Japan? A new inflation target of, say, 2 percent would induce a yawn, considering that few analysts expect the BOJ to hit even the 1 percent goal it adopted in February. Embracing a new target, such as nominal GDP, lacks the simplicity of aiming for higher prices. The central bank could raise the share of corporate bonds, exchange-traded funds and property-backed securities in its asset-purchase program from their current 8 percent level. That would pile more credit risk onto the BOJ’s balance sheet, but would also channel liquidity to non-banks that may use it to boost credit.

A bolder move would be for the monetary authority to use printed money to buy U.S. Treasury bonds until it hits its inflation target. Such a plan would help exporters by weakening the yen, even as it generates domestic liquidity. Currently, the finance ministry orders purchases of foreign securities out of funds that the government borrows and parks in a special account. This roundabout way of weakening the yen through a fiscal operation – rather than a monetary one – only works temporarily, until a fresh bout of global risk aversion makes the yen a compelling haven again.

Purchasing U.S. Treasuries by printing yen would require changes in the institutional arrangements between the BOJ and the finance ministry. It would also be bound to evoke protests in the United States about Tokyo’s blatant currency manipulation. Then again, Japanese purchases would play the same role that outsized Chinese demand for U.S. government and agency debt did until a few years ago: they will help to keep long-term U.S. interest rates low.

The BOJ needs to change its failing strategy. Risks of a new recession are mounting. If the central bank doesn’t come up with a new policy, Japanese consumers will continue to hoard cash and deny the economy what it has craved since 1999: a little bit of inflation.


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