MISSION INCOMPLETE Reflating ’s Economy MISSION INCOMPLETE MissionReflating incomplete! Japan’s Economy This phrase neatly captures the progress made by the (BOJ) in reflating the economy. In April 2013, under its new governor, the BOJ launchedMission incomplete! an unprecedented This phrase quantitative neatly captures and qualitative the progress monetary made easing by the policy. Bank of HaruhikoJapan (BOJ) Kuroda in reflating was certain the economy.that the 2% In priceApril stability2013, under target its wouldnew governor, be achieved the BOJ withinlaunched 2 years. an unprecedented About 5 years quantitativelater, underlying and inflationqualitative and monetary inflation easing expectations policy. have remainedHaruhiko Kurodawell below was 2%. certain While that the the super-easing 2% price stability monetary target policy would has be corrected achieved the overvaluationwithin 2 years. ofAbout the yen 5 years and later,the undervaluation underlying inflation of stock and prices, inflation there expectationsare growing have concernsremained inwell Japan below about 2%. theWhile side the effects super-easing of the policy.monetary Those policy include has correctedasset price the distortions;overvaluation adverse of the impacts yen and on the the undervaluation profitability of stockfinancial prices, institutions; there are growingthe BOJ’s balanceconcerns sheet in Japan risks; about the undermining the side effects of fiscal of the discipline; policy. Those lack includeof strong assetincentives price to accelerate economic growth strategies by the government and firms; and growing distortions; adverse impacts on the profitability of financial institutions; the BOJ’s Reflating Japan’s Economy MISSION INCOMPLETE inequality.balance sheet What risks; went the wrong? undermining And what of fiscal should discipline; the BOJ lackdo next? of strong This incentivesformer policy to maker’saccelerate account economic expertly growth traces strategies and analyzes by the thegovernment policy’s consequences. and firms; and growing Reflating Japan’s Economy MISSION INCOMPLETE 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

TheAbout Asian the Development Asian Development Bank Institute, Bank Institute located in Tokyo, is the think tank of the Asian MISSION Development Bank. The institute aims to identify effective strategies to improve policy andThe developmentAsian Development management Bank Institute, in Asia and located the Pacific. in Tokyo, Weis thework think with tank an extensive of the Asian MISSION networkDevelopment of partners Bank. inThe the institute region and aims globally to identify to influence effective policiesstrategies on topoverty improve reduction, policy inclusiveand development growth, the management environment, in Asia regional and cooperation,the Pacific. infrastructureWe work with an development, extensive middle-income countries, and private sector development. SECOND EDITION INCOMPLETE network of partners in the region and globally to influence policies on poverty reduction, inclusive growth, the environment, regional cooperation, infrastructure development, middle-income countries, and private sector development. SECOND EDITION ReflatingINCOMPLETE Japan’s Economy Reflating Japan’s Economy SAYURI SHIRAI SAYURI SHIRAI SECOND EDITION SECOND EDITION

ASIAN DEVELOPMENT BANK INSTITUTE 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo, 100-6008 Japan ASIAN DEVELOPMENT BANK INSTITUTE Tel +81 3 3593 5500 3-2-5 Kasumigaseki, Chiyoda-ku www.adbi.org ASIAN DEVELOPMENT BANK INSTITUTE Tokyo, 100-6008 Japan Tel +81 3 3593 5500 www.adbi.org ASIAN DEVELOPMENT BANK INSTITUTE Sayuri Shirai, Visiting Scholar Asian Development Bank Institute PhD, Columbia University, United States http://www.sayurishirai.jp [email protected], [email protected] http://www.adb.org/adbi/about/visiting-fellows/

Dr. Sayuri Shirai is a professor at Keio University. She was a member of the Policy Board of the Bank of Japan (BOJ) from April 2011 to March 2016, responsible for making policy decisions. She supported the BOJ’s Quantitative and Qualitative Monetary Easing (QQE) in 2013 and QQE expansion in 2014, but voted against the negative interest rate policy in January 2016. She also taught at Sciences Po in Paris in 2007–2008 and was an economist at the International Monetary Fund (IMF) from 1993 to 1998.

She is the author of numerous books on a variety of subjects including the People’s Republic of China’s exchange rate system, Japan’s macroeconomic policy, IMF policy, and the European debt crisis. Her most recent book (translated title: Unwinding Super-Easy Monetary Policy), published in August 2016, is about the monetary policies of the BOJ, the European , and the Federal Reserve System. She regularly appears on CNBC, Bloomberg, Reuters, BBC, and features in many Japanese TV programs and newspapers, commenting on the Japanese economy and monetary policy. Mission incomplete! This phrase neatly captures the progress made by the Bank of Japan (BOJ) in reflating the economy. In April 2013, the BOJ launched an unprecedented quantitative and qualitative monetary easing policy. The BOJ was certain that the 2% price stability target would be achieved within 2 years. About 5 years later, the BOJ lags behind other major central banks, with actual inflation and inflation expectations still well below 2%. What happened? And what should the BOJ do next? This former policy maker’s account expertly traces and analyzes the policy’s consequences. Contents

Introduction

Chapter 1: Japan’s Malaise And Past Unconventional Monetary Policy (1999–2006) Long-Standing Mild since Late 1990s, Zero Interest Rate Policy and Forward Guidance of 1999–2000, (QE) of 2001–2006, Government Reactions to the Exit Timing

Chapter 2: Comprehensive Monetary Easing (Cme) (October 2010–March 2013) BOJ’s Policy Actions Prior to the Adoption of CME, Basic Features of CME, Adoption of the 2% Price Stability Target, Criticism Related to CME, Macroeconomic Performance under CME

Chapter 3: Quantitative And Qualitative Monetary Easing (Qqe): First Phase of Super-Easy Monetary Policy (April 2013–January 2016) My Proposal Submitted in March 2013, Features of QQE, Transmission Mechanism for Achieving 2% Target and Market Reactions, BOJ’s Decision to Expand QQE in 2014, Assessment of QQE Chapter 4: Qqe with A Negative Interest Rate: Second Phase of Super-Easy Monetary Policy (January–September 2016) Main Features of a Negative Interest Rate, Rationales for Introducing the Complex Three-Tier System, My Opposition to the Negative Interest Rate, Unique Market Reactions to the Policy Announcement, Costs and Benefits of the Negative Interest Rate, BOJ’s Enhancement of Monetary Easing in July 2016

Chapter 5: Qqe with Yield Curve Control: Third Phase of Super-Easy Monetary Policy (September 2016–Present) Features of Yield Curve Control, My Interpretation of the New Framework, Peg or Ceiling and Fixed-Rate Purchase Operations, Practices of Fixed-Rate Purchase Operations, Costs and Benefits of Yield Curve Control, Changing the Composition of ETF Purchases, My Suggestions for the BOJ’s Future Actions

Chapter 6: Structural and Unresolved Issues Of Unconventional Monetary Policy Declining Potential Economic Growth and Monetary Policy, Public Awareness of the 2% Target, Public’s Upward Bias in Price Perception and Acceptance of 2% Inflation, Understanding Households’ and Firms’ Inflation Expectations, What We Learned from Japan’s Unconventional Monetary Policy, Unresolved Issues Bank of Japan’s Unconventional Monetary Policy

Japan as a Front-Runner of Unconventional Monetary Policies Although the Bank of Japan (BOJ) was a front-runner of unconventional monetary policies—such as asset purchases and forward guidance—with innovative measures from the late 1990s, it failed to overcome mild deflation. In April 2013, the BOJ made a significant leap from its past monetary policy practices in terms of the scale and depth of monetary accommodation under Quantitative and Qualitative Monetary Easing (QQE). This book provides more information and rich analysis.

Why Is a Negative Interest Rate Not Workable in Japan? In January 2016, the BOJ surprised the markets with its announcement of a negative interest rate policy after repeated dismissals of its usefulness. This book explains the framework and mechanism of the policy and why it was not supported in Japan.

Yield Curve Control: Why Was It Adopted and How Effective Has It Been? The BOJ’s adoption of yield curve control in September 2016 was a clear departure from the volume-centered approach under QQE with a correction of adverse impacts caused by a negative interest rate. It helped the yen to depreciate and stock prices to rise after the United States (US) presidential election, but has generated uncertainty about the BOJ’s monetary easing stance. This book provides details of the new framework and my interpretations and suggestions. How Far Could Central Banks Count on Currency Depreciation? Achieving the 2% price stability target seems a distant prospect unless there is a sharp oil price hike or currency depreciation. QQE helped to correct an overvalued yen and undervalued stock prices. There are views in the exchange markets that the depreciation since the US presidential election has exceeded the fundamental level. Is undervalued currency sustainable for a large economy with small trade openness such as Japan? What impact will it have on households and firms? The book examines these issues through an overview of Japan’s recent history.

What Factors Deter the Effects of Unconventional Monetary Policies? Unconventional monetary easing tools are quite effective in terms of lowering interest rates and yields, but their effects have been disappointing in terms of raising aggregate demand, underlying inflation, and long-term inflation expectations. This book focuses on some of the issues that may be affecting the effectiveness of such policies based on Japan’s experience—in terms of demographics and households’ upward bias in perceived inflation. This book also points out unresolved issues that have become crucial after the adoption of super-easy monetary policy. MISSION INCOMPLETE MISSIONReflating Japan’s INCOMPLETE Economy Reflating Japan’s Economy Mission incomplete! This phrase neatly captures the progress made by the Bank of MissionJapan (BOJ) incomplete! in reflating This thephrase economy. neatly In captures April 2013, the underprogress its newmade governor, by the Bankthe BOJ of Japan (BOJ)launched in reflating an unprecedented the economy. quantitative In April 2013,and qualitative under its newmonetary governor, easing the policy.BOJ launched an unprecedentedHaruhiko Kuroda quantitative was certain and that qualitative the 2% price monetary stability easing target wouldpolicy. beHaruhiko achieved Kuroda was certainwithin 2that years. the About 2% price 5 years stability later, target underlying would beinflation achieved and within inflation 2 years. expectations About 5 years have later, underlyingremained well inflation below and 2%. inflation While the expectations super-easing have monetary remained policy well hasbelow corrected 2%. While the the super- easingovervaluation monetary of policythe yen has and corrected the undervaluation the overvaluation of stock of prices,the yen there and theare undervaluationgrowing of stockconcerns prices, in Japan there aboutare growing the side concerns effects in ofJapan the policy.about theThose side include effects asset of theprice policy. Those includedistortions; asset adverse price distortions; impacts on adverse the profitability impacts onof thefinancial profitability institutions; of financial the BOJ’s institutions; the BOJ’s balance sheet risks; the undermining of fiscal discipline; lack of strong incentives to 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. accelerate economic growth strategies by the government and firms; and growing What went wrong? And what should the BOJ do next? This former policy maker’s account Reflating Japan’s Economy MISSION INCOMPLETE inequality. What went wrong? And what should the BOJ do next? This former policy expertly traces and analyzes the policy’s consequences. maker’s account expertly traces and analyzes the policy’s consequences.

About the AsianDownload Development for free atBank Institute https://www.adb.org/publications/mission-incomplete-reflating-japan-economy The Asian Development Bank Institute, located in Tokyo, is the think tank of the Asian MISSION 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 Aboutnetwork theof partners Asian in Development the region and globally Bank Instituteto influence policies on poverty reduction, inclusive growth, the environment, regional cooperation, infrastructure development, Themiddle-income Asian Development countries, Bank and privateInstitute, sector located development. in Tokyo, is the think tank of the Asian SECOND EDITION INCOMPLETE 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 Reflating Japan’s Economy partners in the region and globally to influence policies on poverty reduction, inclusive growth, the environment, regional cooperation, infrastructure development, middle-income countries, and private sector development. SAYURI SHIRAI

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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