GROWING CENTRAL BANK CHALLENGES IN THE WORLD AND JAPAN Low Inflation, Monetary Policy, and Digital Currency Sayuri Shirai ASIAN DEVELOPMENT BANK INSTITUTE Growing Central Bank Challenges in the World and Japan: Low Inflation, Monetary Policy, and Digital Currency By Sayuri Shirai ASIAN DEVELOPMENT BANK INSTITUTE © 2020 Asian Development Bank Institute All rights reserved. ISBN 978-4-89974-223-4 (Print) ISBN 978-4-89974-224-1 (PDF) The views in this publication do not necessarily reflect the views and policies of the Asian Development Bank Institute (ADBI), its Advisory Council, ADB’s Board or Governors, or the governments of ADB members. ADBI does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. ADBI uses proper ADB member names and abbreviations throughout and any variation or inaccuracy, including in citations and references, should be read as referring to the correct name. By making any designation of or reference to a particular territory or geographic area, or by using the term “recognize,” “country,” or other geographical names in this publication, ADBI does not intend to make any judgments as to the legal or other status of any territory or area. Users are restricted from reselling, redistributing, or creating derivative works without the express, written consent of ADBI. The Asian Development Bank recognizes "China" as the People's Republic of China, "Korea" as the Republic of Korea, and "Vietnam" as Viet Nam. Note: In this publication, “$” refers to US dollars. Asian Development Bank Institute Kasumigaseki Building 8F 3-2-5, Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan www.adbi.org Contents Tables and Figures iv Abbreviations vi Introduction 1 PART I: Low Inflation and Monetary Policy Challenges 1. Inflation Targets and Low Inflation 9 2. Unconventional Monetary Policy Adopted in Developed Economies 38 3. Bank of Japan’s Stock Purchases as an Unconventional Monetary Tool 79 4. Growing Interest in Alternative Monetary Policy Frameworks 94 5. Better Coordination between Monetary Policy and Fiscal Policy 108 PART II: Cash, Crypto Assets, and Central Bank Digital Currency 6. Cashless Payment and Cash Hoarding 129 7. Bank Money, Crypto Assets, and Stablecoins 145 8. Central Bank Digital Currency: Proposals and Prospects 173 References 198 !iii Tables and Figures Tables 5.1 Diferences between Modern Monetary Theory and Bank of Japan’s Monetary Easing 121 7.1 Features of Central Bank Money and Private Money 146 7.2 Features of Bitcoin, Tether, and Libra 163 Figures 1.1 Inflation in the Euro Area, Japan, and the United States (%) 16 1.2 Core Inflation in the Euro Area, Japan, and the United States (%) 18 1.3 Three Types of Core Inflation Indicators in Japan (%) 19 1.4 Long-Term Inflation Expectation Indicators in the Euro Area (%) 25 1.5 Long-Term Inflation Expectation Indicators in Japan (%) 25 1.6 Long-Term Inflation Expectation Indicators in the United States (%) 26 1.7 Actual Inflation, Perceived Inflation, and Long-Term Inflation Expectations in Japan (%) 31 1.8 Real Gross Domestic Product and Its Composition (Year 2000 Q1 = 100) 33 2.1 Financial Assets Held by the European Central Bank, Bank of Japan, and the Federal Reserve ($ trillion) 42 2.2 Financial Assets Held by the European Central Bank, Bank of Japan, and the Federal Reserve (% of nominal GDP) 43 2.3 New Lending Rate and Deposit Rate in Japan (% ) 61 2.4 Degree of Bond Market Functioning in Japan (percentage points) 63 3.1 Nikkei 225 and Tokyo Stock Price Index 80 3.2 Tokyo Stock Price Index, Textile and Apparel Index, and the Stock Price of Fast Retailing 87 4.1 Desired Long-Term Price Level Path and Actual Price Level 100 4.2 Japan’s Nominal Gross Domestic Product Target and International Monetary Fund Projection (¥ trillion) 103 4.3 Nominal Wages per Employee (year/year %) 105 5.1 Bank of Japan’s Balance Sheet 122 iv! Tables and Figures v 6.1 Cash in Circulation in Selected Developed Economies (% of nominal gross domestic product) 133 6.2 Cash in Circulation in Selected Emerging Economies (% of nominal gross domestic product) 137 6.3 Banknotes Issued by Denomination in Japan (¥ billion) 140 6.4 Banknotes Issued by Denomination in the United States ($ billion) 140 6.5 Banknotes Issued by Denomination in the Euro Area (€ billion) 141 7.1 Bitcoin Price and Market Capitalization 151 7.2 Tether Price and Market Capitalization 155 8.1 Types of Central Bank Digital Currency Proposals 182 Abbreviations AML anti-money laundering BIS Bank for International Settlements BOJ Bank of Japan CBDC central bank digital currency CFT combating the financing of terrorism CME comprehensive monetary easing coronavirus disease COVID-19 CPI consumer price index DCEP digital currency electronic payment DI difusion index DLT distributed ledger technology DVP delivery versus payment ECB European Central Bank ETF exchange-traded fund EU European Union FDI foreign direct investment FINMA Swiss Market Financial Supervisory Authority fintech financial technology FOMC Federal Open Market Committee G7 Group of Seven GDP gross domestic product GPIF Government Pension Investment Fund HICP Harmonized Index of Consumer Prices HKMA Hong Kong Monetary Authority ICO initial coin ofering IMF International Monetary Fund IT information technology JGB Japanese government bond J-REIT Japanese real estate investment trust LSAP large-scale asset purchase MAS Monetary Authority of Singapore MMT modern monetary theory NIRI non-inflationary rate of inflation NISA Nippon Individual Savings Account PELTRO pandemic emergency longer-term refinancing operation PCE personal consumption expenditure vi! Abbreviations vii PRC People’s Republic of China QQE quantitative and qualitative easing ROE return on equity R&D research and development SDR special drawing right TLTRO targeted longer-term refinancing operation TOPIX Tokyo Stock Price Index US United States USC utility settlement coin YCC yield curve control Introduction Central banks are facing growing challenges posed by aging, low productivity, new technology, and innovation especially after the global financial crisis triggered by the collapse of Lehman Brothers in 2008. The challenges that are under the spotlight globally can be grouped into two issues: (i) low inflation and related impacts of unconventional monetary policy, as well as policy coordination including fiscal stimulus, and (ii) the wide range of recent issues related to central bank money (cash), private money (bank deposits), emergence of private crypto assets, and threats posed by Facebook’s Libra plan, as well as the prospect of a central bank digital currency. The first challenge is related to persistently low inflation observed in some developed economies even after various unconventional monetary easing tools have been adopted for many years when short-term interest rates have fallen into the efective lower bound. Employment conditions have improved remarkably, stock and real estate prices have risen, and currency depreciation has occurred in some economies. Nonetheless, inflation has remained below the numerical inflation target for most of the time since the 2008 financial crisis. Inflation underperformance has been prevalent in the euro area, Japan, and, to a lesser extent, the United States. Various unconventional monetary easing tools—such as large-scale asset purchases, forward guidance, negative interest rate, yield curve control, stock exchange-traded fund (ETF) purchases— have been experimented with by several central banks. It appears that many central banks prefer forward guidance and large-scale asset purchases to a negative interest rate. Yield curve control (stabilizing the short-term policy rate and a 10-year yield), adopted by the Bank of Japan since 2016, is receiving attention from some central banks. The Reserve Bank of Australia followed the Bank of Japan in March 2020 by attempting to stabilize a shorter 3-year yield. The United States Federal Reserve has been discussing the possible adoption of yield curve control focusing on a shorter maturity like the Reserve Bank of Australia. ETF purchases are so far conducted only in Japan. It is uncertain how long unconventional monetary easing will continue in the low inflationary environment although various adverse impacts are growing. Given the weak outcomes of unconventional monetary policy tools to raise inflation, furthermore, alternative monetary frameworks— such as average inflation targeting and price-level targeting—and policy coordination using fiscal stimulus have been intensively discussed in !1 2!Growing Central Bank Challenges in the World and Japan the central banking circle especially at the Federal Reserve and in academia. Moreover, the weaker relationship between unemployment and inflation—called a “flattened Phillips curve”—has invited various arguments. The Phillips curve also applies to the relationship between the output gap (namely, the diference between actual and potential output or, simply, the supply-demand balance) and inflation. Some central banks claim that the flattened Phillips curve indicates the successful outcome of flexible inflation targeting since inflation has become less reactive to changes in the unemployment gap (the gap between the current rate of unemployment and the natural rates of unemployment) and more reactive to long-term inflation expectations. However, persistent inflation underperformance calls into question whether this view remains valid. It may suggest that inflation expectations have dropped and are no longer well-anchored at around the inflation target. The flattened Phillips curve might also mean the relationship between unemployment and inflation has weakened. If this is true, this generates a challenging environment for some central banks since they may find it difcult to provide accurate inflation forecasts. The second challenge this book deals with is issues related to money, crypto assets, and central bank digital currency. Cash demand (beyond nominal gross domestic product [GDP]) grew after the global financial crisis of 2008–2009 in some developed economies—including the euro area, Japan, the Republic of Korea, Singapore, the United Kingdom, and the United States—despite cashless payment tools gaining popularity.