Japan withdraws from largest monetary-policy experiment in history

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Japan withdraws from largest monetary-policy experiment in history

A radical monetary policy the experiment is almost over. On March 19, Bank of Japan officials (BoJ.) announced that with 2% inflation “in sight,” they would abandon a series of measures instituted to pull the economy out of its deflationary doldrums. The bank raised its key interest rate for the first time since 2007, from -0.1% to between 0 and 0.1%, becoming the last central bank in the world to end its interest rate policy. negative interest. It will also stop buying exchange-traded funds and abolish its yield curve control framework, a tool intended to cap long-term bond returns. Despite everything, the BoJ. He also made clear that his stance would remain broadly accommodative: the withdrawal of his most unconventional policies does not augur the start of a tightening cycle.

This change reflects changes in the underlying situation of the Japanese economy. Inflation has been higher than the bank’s 2% target for 22 months. Data from annual negotiations between unions and big business released last week suggests wage growth above 5% for the first time in 33 years. “THE BoJ. confirmed what many suspected: the Japanese economy has changed, it has emerged from deflation,” says Hoshi Takeo of the University of Tokyo. This does not mean that Japan is booming: consumption is weak and growth is anemic. But the economy no longer needs a full arsenal of policies designed to increase inflation. When Ueda Kazuo, the BoJ.It is governor, he was asked what name he would give to his new cadre, he replied that it did not require a special name. It was “normal” monetary policy.

image: The Economist

The Japanese economy slipped into deflation in the 1990s, following the bursting of an asset bubble and the bankruptcy of several financial institutions. THE BoJ. started trying new tools cautiously at first. Although in 1999 the bank lowered interest rates to zero, it raised them the following year, only to see prices fall again (one of two board members opposed the move at the time was Mr. Ueda). THE BoJ. then went further, becoming the first post-war central bank to implement quantitative easing – buying bonds with newly created money – in 2001.

Yet he did not fully embrace the wild side of monetary policy until Kuroda Haruhiko took over as governor in 2013. Supported by then-Prime Minister Abe Shinzo, Mr. Kuroda embarked on a sweeping program of monetary easing, promising to free a recovery “bazooka”. The bank adopted a 2% inflation target and launched “quantitative and qualitative easing”, which saw huge purchases of government bonds coupled with aggressive forward guidance (promises to maintain easy policy) . In 2016, the bank set its overnight policy rate at minus 0.1%, then implemented yield curve control to contain long-term interest rates as well. Although inflation accelerated slightly, it never consistently met the central bank’s target during Mr. Kuroda’s tenure, which ended nearly a year ago.

Officials are now convinced that inflation is finally anchored and that the Japanese economy is strong enough to avoid extreme measures. Supply chain problems and rising import costs initially pushed inflation higher, but price increases have since become widespread. GDP growth figures for the final quarter of 2023 were recently revised into positive territory due to an uptick in capital expenditure.

image: The Economist

The missing piece of the puzzle was wages. Last year, annual wage negotiations produced gains of 3.8%, the highest in three decades. But wage growth remains below inflation itself, leading to a decline in real incomes. Then came last week’s blockbuster numbers. They included a sharp increase in the so-called base part of Japanese salaries, which is not linked to seniority. A prolonged period of rising prices encouraged unions to lobby forcefully for higher wages; Japan’s shrinking workforce is also forcing companies to compete for talent. Policymakers “have been very, very patient, deliberately waiting for the right moment,” says Nakaso Hiroshi, former BoJ. deputy governor. “And now the time has come.”

For such an important decision, the short-term impact will likely be limited. THE BoJ. had hinted at its intentions in advance, meaning the markets priced in the move. The yen depreciated slightly against the dollar following this announcement. The bank had already relaxed its yield cap last year. Long-term yields have stabilized around 0.7% to 0.8%, below the abandoned benchmark of 1%. Although some Japanese investors may repatriate funds following this policy change, global capital flows are unlikely to change drastically, as rates in Japan will remain quite low by international standards, notes Kiuchi Takahide of the Nomura Research Institute, a research organization. The change in the key rate will not have any major effect either: within the framework of the BoJ.Under the old framework, there were three levels of accounts and the share of funds held in those subject to negative rates was minimal.

The big question is where BoJ. it starts from here. Officials were careful to signal that they were not embarking on a cycle of tightening. In a speech last month, Uchida Shinichi, vice governor, said there would be no rapid series of rate hikes. Mr. Ueda has given few clues about where he suspects rates will stabilize; most economists estimate that they will not exceed 0.5%. THE BoJ. It will also continue to buy “about the same amount” of government bonds to continue controlling long-term rates. Normalizing its own balance sheet will be a gradual process. “THE BoJ. has left a huge mark on the market,” says Kato Izuru of think tank Totan Research. “They want to reduce that footprint, but it can’t be reduced all at once. »

Currency threat

As the BoJ. As the country enters its new era of policymaking, several risks loom. One is from overseas. A slowdown in America or China, Japan’s two main trading partners, would weigh on external demand and weigh on the prospects of Japanese companies, making them less likely to invest.

Another risk comes from within. In the long term, interest payments on Japan’s large public debt will increase, putting pressure on public finances. The financial system appears strong, but Japan’s financial regulator recently increased monitoring of regional lenders’ loan portfolios. Many observers are concerned about the impact of rate hikes on mortgages and on small and medium-sized businesses that do not have significant cash reserves.

The most worrying thing is that inflation could fall below the target again. Price inflation, although still above 2%, is already falling. Two rather dovish board members voted against the decision to abolish negative interest rates, arguing that more time was needed to ensure inflation would persist. For this trend to continue, Japan needs reforms that increase productivity and boost the potential growth rate, Nakaso says. If there is one lesson to be learned from Japan’s era of monetary policy experiments, it is that there are limits to the powers of central banks. In Japan’s new era, others will have to take the lead.

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