QE Failed To Spur Bank Lending In Japan

bank of japan 4x3
The Bank of Japan.

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Japan lost a decade of growth after the collapse of its debt-financed bubble economy in 1990.Politicans grew impatient at the economy’s lack of progress.

The pressure intensified for extreme monetary measures to jumpstart economic growth.

Quantitative easing became the tool of choice.

Unfortunately, it failed to increase bank lending.

Financial institutions did not attempt to rebalance their portfolios by shifting away from excess reserves at the BOJ to loans.4 As Richard Koo states, “The Bank of Japan (BOJ) argued vigorously that such measures would be meaningless, but it was eventually overidden, and in March 2001 then Governer Masaru Hayami made the decision to implement quantitative easing.

During the period between March 2001 and March 2006, the Bank of Japan pumped 25 trillion yen of reserves–equivalent of five times banks’ required reserves into the system.

Yet, the money supply grew only by an amount equal to the increase in government borrowing over private-sector debt repayment during this period”.

He goes on to explain why QE fails to work in a zero interest rate environment, “The central bank’s implementation of quantitative easing at a time of zero interest rates was similar to a shopkeeper who, unable to sell more than 100 apples a day at 100 Yen each, tries stocking his shelves with 1,000 apples, and when that has no effect, adds another 1,000.

As long as the price remains the same, there is no reason consumer behaviour should change–sales will remain stuck about 100 even if the shopkeeper puts 3,000 apples on the display”.

Japanese policymakers confronted another roadblock to economic recovery. Besides the lack of private sector borrowing emanating from the balance sheet recession, low inflation rates risked discouraging consumption and investment spending.  

After the bubble burst in 1990, Japanese CPI rates declined from an annual peak of 2.6% to a negative reading as early as 1999. As a result, Japan tried to eradicate deflationary pressures. Over the program’s five-year period, the BOJ increased the reserve target nine times and (similar to the U.S Fed in 2009) increased its purchases of longer-dated Japanese government securities.

CPI Japan

Furthermore, the central bank promised to maintain the policy until core CPI reach zero or increased on a y-o-y basis for several months, which equated to setting an inflation target.

While inflation turned positive in the first quarter 2006, it did so by a paltry 0.2%.The QE policy ended and Japan fell back into deflation by year’s end, with an annual 2006 CPI reading of -0.4%. In fact, up to the year 2010, the highest Japanese annual CPI reading came in at 0% in 2008 during the peak of the commodity boom.

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