Mission Incomplete: Reflating Japan's Economy
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MISSION INCOMPLETE Reflating Japan’s Economy Mission incomplete! This phrase neatly captures the progress made by the Bank of Japan (BOJ) in reflating the economy. In April 2013, under its new governor, the BOJ launched an unprecedented quantitative and qualitative monetary easing policy. Haruhiko Kuroda was certain that the 2% price stability target would be achieved within 2 years. About 5 years later, underlying inflation and inflation expectations have remained well below 2%. While the super-easing monetary policy has corrected the overvaluation of the yen and the undervaluation of stock prices, there are growing concerns in Japan about the side effects of the policy. Those include asset price distortions; adverse impacts on the profitability of financial institutions; the BOJ’s balance sheet risks; the undermining of fiscal discipline; lack of strong incentives to accelerate economic growth strategies by the government and firms; and growing inequality. What went wrong? And what should the BOJ do next? This former policy maker’s account expertly traces and analyzes the policy’s consequences. About the Asian Development Bank Institute MISSION The Asian Development Bank Institute, located in Tokyo, is the think tank of the Asian Development Bank. The institute aims to identify effective strategies to improve policy and development management in Asia and the Pacific. We work with an extensive network of partners in the region and globally to influence policies on poverty reduction, INCOMPLETE inclusive growth, the environment, regional cooperation, infrastructure development, middle-income countries, and private sector development. Reflating Japan’s Economy SAYURI SHIRAI SECOND EDITION ASIAN DEVELOPMENT BANK INSTITUTE 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo, 100-6008 Japan Tel +81 3 3593 5500 www.adbi.org ASIAN DEVELOPMENT BANK INSTITUTE MISSION INCOMPLETE Reflating Japan’s Economy SAYURI SHIRAI SECOND EDITION ASIAN DEVELOPMENT BANK INSTITUTE © 2018 Asian Development Bank Institute All rights reserved. Published in 2018. ISBN 978-4-89974-097-1 (Print) ISBN 978-4-89974-098-8 (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. Notes: In this publication, “$” refers to United States dollars. ADB refers to “China” by the name People’s Republic of China. Asian Development Bank Institute Kasumigaseki Building 8F 3-2-5, Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan www.adbi.org CONTENTS TABLES AND FIGURES viii INTRODUCTION 1 CHAPTER 1 JAPAN’S MALAISE AND UNCONVENTIONAL MONETARY EASING FROM 1999 TO 2006 5 1.1 Long-Standing Mild Deflation since the Late 1990s 5 1.2 Zero Interest Rate Policy and Forward Guidance of 1999–2000 11 A. Adoption of the Zero Interest Rate Policy 12 B. Lifting of the Zero Interest Rate Policy and the Government’s Opposition 13 1.3 Quantitative Easing (QE) of 2001–2006 15 A. The Features of the QE Policy 15 B. Improved Economic Performance during 2001–2006 17 C. Moderately Improved Price Performance during 2001–2006 17 D. Decision to Exit from QE Policy and Government’s Concerns over the Exit Decision 18 E. Introducing an Understanding of Price Stability 20 F. Reflections on the Timing of Exit from QE Policy 21 CHAPTER 2 COMPREHENSIVE MONETARY EASING (CME) FROM OCTOBER 2010 TO MARCH 2013 24 2.1 BOJ’s Policy Actions prior to the Adoption of CME 24 2.2 Basic Features of CME 28 A. Establishing the Asset Purchase Program 29 B. Introducing an Open-Ended Asset Purchasing Method from 2014 31 2.3 Forward Guidance and Adoption of the 2% Price Stability Target 31 A. Evolution of Forward Guidance on the Monetary Easing Stance 32 B. BOJ’s Initial View on Price Stability 33 C. Adoption of the 2% Price Stability Target through the Joint Statement with the Government 33 iii iv CONTENTS 2.4 Issues and Criticism Related to the Framework of CME 35 A. Complexity Arising from the Two Asset Purchase Operations 35 B. Perceived as a Piecemeal Approach and Lack of Boldness 38 C. Limitation of the Asset Purchase Program under CME 39 2.5 Macroeconomic Performance under CME 40 A. Yen’s Overvaluation and Sluggish Stock Price Developments 40 B. Sluggish Price Developments and Long-Term Inflation Expectations 41 C. Experiences in the United Kingdom 44 CHAPTER 3 QUANTITATIVE AND QUALITATIVE MONETARY EASING (QQE): FIRST PHASE OF SUPER-EASY MONETARY POLICY FROM APRIL 2013 TO JANUARY 2016 47 3.1 The Three Phases of Super-Easy Monetary Policy 47 3.2 My Proposal on Monetary Expansion Submitted in March 2013 48 3.3 The Features of the QQE Policy 49 A. Monetary Base Control under QQE 50 B. Mr. Kuroda’s Confidence about Achieving 2% Inflation in 2 Years 52 C. Similarities and Differences between QQE and My Proposal 53 D. Comparable to the Federal Reserve’s Asset Purchase Program 54 3.4 Four Features Related to the QQE Framework 55 A. Emphasis on Inflation Expectations with the Monetary Base Target 55 B. JGB Purchases as a Main Monetary Easing Instrument 56 C. Increasing the Amount of Risk Asset Purchases 57 D. Clear and Effective Communication Strategies with Keyword “2” 58 E. Differences between QQE and Past Practices 58 3.5 Forward Guidance on the Stance of Monetary Policy under QQE 59 A. Forward Guidance under QQE 59 B. Relationships between the Two Descriptions 60 C. What Does “In a Stable Manner” Mean? 61 3.6 Transmission Mechanism for Achieving the 2% Target and Market Reactions 62 A. QQE’s Expected Impacts on Long-Term Interest Rates 63 B. Major Transmission Channels through Lowering Real Interest Rates 64 C. Transmission Channel through Portfolio Rebalancing 64 CONTENTS v D. Transmission Channel through the Exchange Rate Effect 66 E. Impact of the QQE Policy on Financial Markets 66 3.7 BOJ’s Decision to Expand QQE in October 2014 68 A. Large-Scale Expansion of the Monetary Base and JGB Purchase 69 B. Communication Strategy Using Keyword “3” 69 C. BOJ’s Rationales for Expanding QQE 70 D. My Outlook on Prices and My Support for QQE Expansion 70 3.8 Assessment of QQE and QQE Expansion and BOJ’s Evaluation 73 A. Revised GDP Data and Stagnant Sales and Wage Growth 73 B. Favorable Changes in Firms’ Price-Setting Behavior 76 CHAPTER 4 QQE WITH A NEGATIVE INTEREST RATE: SECOND PHASE OF SUPER-EASY MONETARY POLICY FROM JANUARY TO SEPTEMBER 2016 80 4.1 M ain Features of QQE with a Negative Interest Rate 80 A. How Does the Three-Tier System Work? 82 B. Adjustment to Prevent Financial Institutions’ Cash Holdings 85 C. Upper Bounds Creating Arbitrage Opportunities 86 D. Providing Exemptions from a Negative Interest Rate on Money Reserve Funds (MRF) 92 E. Forward Guidance about Future Monetary Easing Stance 94 4.2 R ationales for Introducing the Complex Three-Tier System 95 A. M itigating the Adverse Impact on Banking Sector Profitability 95 B. Negative Interest Rate Policy of the Swiss National Bank 96 C. Maintaining the Function of the Money Markets 98 4.3 M y Opposition to the Timing of Introducing the Negative Interest Rate 105 A. W as a Negative Rate Necessary When the BOJ Was Confident about Domestic Demand Performance? 106 B. Inconsistency with the Asset Purchase Program 107 C. Comparison with the ECB and Expected Repeated Requests for a Rate Cut 108 D. Suitable Timing to Adopt a Negative Interest Rate 109 4.4 Unique Market Reactions to the Policy Announcement 110 A. P ositive Surprise Turning to Negative Shocks in Just Two Days 110 vi CONTENTS . B Why Were the Market Reactions Reversed? 111 C. Biggest Drop in JGB Yields since the Introduction of QQE 112 4.5 Benefits under the Negative Interest Rate Policy 114 A. Growing Residential Investment and J-REIT Market 114 B. Growing Issuance of Longer-Term Corporate Bonds 118 C. More Active Foreign Portfolio Investment 119 4.6 Cost and Side Effects of the Negative Interest Rate Policy 121 A. Weakened Liquidity and Function of JGB Markets 121 B. Growing Concerns over the Financial Instability Risk 127 C. Adverse Impacts on Corporate Sector Pension Funds and Household Sentiment 130 D. BOJ’s Operational Challenge and Balance Sheet Risk 132 4.7 BOJ’s Enhancement of Monetary Easing in July 2016 140 A. Expanding the ETF Purchases 141 B. Helping to Smoothen US Dollar Funding by Japanese Financial Institutions 142 C. Announcement of the Comprehensive Assessment of the Ongoing Monetary Easing Measures 143 CHAPTER 5 QQE WITH YIELD CURVE CONTROL: THIRD PHASE OF SUPER-EASY MONETARY POLICY FROM SEPTEMBER 2016 TO THE PRESENT 145 5.1 The Features of QQE with Yield Curve Control 145 A. New Policy Framework 146 B. Changing the Composition of ETF Purchases 148 5.2 Complexity and Ambiguity of the New Framework 149 A. Dropping the Quantity Dimension 150 B. A Reverse Operation Twist 155 C. The Peg versus Ceiling on the 10-Year Yield 158 D.