Tuesday, January 26, 2010

Japan rescinds war on deflation

At least that is the way I read today’s monetary policy release. According to the statement released today: “The Bank of Japan will encourage the uncollateralized overnight call rate to remain at around 0.1 percent.” However, the statement curiously omits the following from item 6. of the previous release:
The Policy Board has concluded that it is appropriate to further disseminate the Bank's thinking on price stability, by stating more clearly that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent and that the midpoints of most Policy Board members' "understanding" are around 1 percent.
I don’t know why the Bank of Japan would rescind their commitment to 0 percent, when the median inflation projection is negative through 2011, although improved from its latest forecast in June 2009 (at the end of the January 2010 policy statement). That’s bad – rising real debt, further hits to consumer spending, the works. Admittedly, there’s debate over the actual benefit of quantitative easing and zero-interest rate policy (see this paper at the FRSB).

But another policy-relevant bit of news hit the wire today: S&P put Japan’s credit rating on negative watch. From the NY Times:
“The outlook change reflects our view that the Japanese government’s diminishing economic policy flexibility may lead to a downgrade unless measures can be taken to stem fiscal and deflationary pressures,” S.&P. said. “The policies of the new Democratic Party of Japan government point to a slower pace of fiscal consolidation than we had previously expected.” Prime Minister Yukio Hatoyama has some lofty spending plans in its budget, funded by an expected 44.3 tn yen bond issuance.
Diminishing policy flexibility? Given the central bank’s propensity to move away from the ZIRP, and the government debt running stock at 183% of GDP (and rising), I’d say that diminishing policy flexibility is a euphemism.


Notice how Japan's government debt rose while the nonfinancial sector's obligations fell - that's the deleveraging story.

Japan is not “insolvent”, at least that is what the external debt metrics say. But the only real policy flexibility is held by the central bank. And the Bank of Japan, ostensibly at least, doesn’t seem to be providing adequate liquidity.

If left unchecked, this could happen to the U.S.: policy mistakes. Raising taxes and hiking rates too early can turn into persistent economic problems.

Rebecca Wilder


  1. So, do we keep Bernanke to keep the ship of state afloat? Looks like its a done deal anyway. And Boxer and Feinstein are on opposite sides again! Whoop! aj

  2. The Central Banks are political. The old saying applies: Watch what they do, not what they say.

    The FRBSF article talks of Keynes's fallacious "liquidity trap", when the technical staff should be talking about "pushing on a string".

    With "government debt running stock at 183% of GDP" the BOJ has ample eligible collateral/assets (to offset the expansion of Central Bank's liabilities on its balance sheet, legal reserves, etc).

    It is right for the BOJ to adopt an explicit inflation-targeting regime. That's all a Central Bank should be concerned with. It is the only achievable objective.

  3. The BOJ can control its money stock using two tools:
    (1) legal reserves, and
    (2) reserve ratios.

    The BOJ can monetize an unknown, but substantial percentage, of its government debt, by simply raising reserve ratios.

    The US intends to use interest on reserves (IORs), to achieve the same objective.

    The false Keynesian doctrine: that the money supply could be properly controlled through the manipulation of interest rates, already results in a delayed, remote, and approximate control over the lending and money-creating capacity of the banking system.

    I.e., the effect of Fed operations, on all except the very short-end of the market (and then only temporarily), is INDIRECT, and varies WIDELY over time, and in MAGNITUDE.

    Since the FED can hold interest rates, at a given target, for a considerably longer time period (using IORs), the chance of policy error will be exacerbated, and in the end, will be cataclysmic.