Today the Bank of Japan surprised markets by announcing more quantitative easing.
Before, the BoJ was buying a staggering 70 trillion yen ($887 billion) as part of its program of asset purchases. Today, they upped it an additional 10 trillion yen ($127 billion).
Japan has been trying unconventional monetary policies for years since a credit crunch in 1998-1999 that plunged the economy into a deflationary spiral.
Deutsche Bank economist Mikihiro Matsuoka provides the details in a note to clients today – and he also explains why the additional easing just announced today just still isn’t enough to achieve the central bank’s goal of ending deflation:
The APP has widened from an initial ¥30trn at end-October 2011 (fixed-rate funds- supplying operations) to ¥52.7trn as of end-August 2012. This translates to a rapid annualized pace of ¥27.2trn (5.8% of GDP). However, the BoJ’s total assets in the same period have risen only ¥17trn (annualized ¥20.4trn, 4.3% of GDP). This is because it has gotten rid of assets not included in the program. Assuming (optimistically) that it does not continue to resort to such means, it should have leeway for ¥27.3trn in further buying (i.e., ¥80trn – ¥52.7trn) in the 16 months to end-2013. This represents an annualized ¥20.5trn (4.3% of GDP), around the same pace as the past 10 months. We estimate that the monetary base needs to be increased ¥100trn in order to raise inflation from -1% to +1%, and believe this should be carried out ideally over a three-year period.
This would take five years at the present rate of balance sheet expansion. That is, the current purchasing pace appears insufficient to achieve 1% core inflation. Still, the continued expansion in the balance sheet should help rein in upward pressure on the yen and support asset prices, thus relieving the downward pressure on the economy. The main reason that monetary easing is considered effective even under zero short-term interest rates is that central bank debt (monetary base) is an imperfect substitute for domestic nonfinancial sector debt (e.g. government debt, corporate bonds, loans).
The chart below shows Japan’s Consumer Price Index ex-food and energy, which went negative near the end of the 1990s. It recovered before the collapse of Lehman Brothers in 2008, when the ensuing crisis once again plunged the Japanese economy into deflation.
The index has been unable to make it into positive territory since, and it’s seen some volatility:
A recent paper by University of Tokyo economist Kazuo Ueda published in The Japanese Economic Review takes a look at whether the Bank of Japan’s various easing measures over the past 15 years have really been effective in fighting deflation.
The table below, taken from Kazuo’s paper, shows the effects of the BoJ’s various unconventional monetary policy measures since 1999. The grey shaded cells indicate when asset prices moved as expected in reaction to the policies.
What’s clear is that the BoJ has been successful in boosting stock prices and depressing bond yields, but has had relatively little success influencing the exchange rate of the yen versus the dollar (look at the right-most column):
Photo: Ueda (2012)
And when the statistical significance of the BoJ’s policy announcements on the reactions of various asset classes is examined, it’s evident that the BoJ has been even less successful influencing the dollar/yen exchange rate.
The grey shaded cells in the table below show which policies had statistically significant effects (only three times was the dollar/yen rate really affected):
Photo: Ueda (2012)
And here is the dollar versus the yen (in red) overlayed with the BoJ’s interventions in the dollar-yen foreign exchange market (in blue):
The yen refuses to weaken.
Kazuo’s conclusion for the BoJ is pretty grim:
Consequently, an extensive use of non-conventional monetary policy measures, unless it succeeds in turning the economy around within a reasonably short period of time, may run the risk of undermining the economy’s ability to find profitable investment opportunities. Needless to say, had the ZIRP or QEJ succeeded in raising inflation expectations on a significant scale for a sustained period, interest rate spreads would have increased. The entrenched nature of deflationary expectations, however, seems to have prevented this. Unfortunately, the Japanese economy seems to be trapped in an “equilibrium” whereby only exogenous forces generate movements to a better equilibrium with a higher rate of inflation.
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