To end or not to end. That is the question. The Bank of Japan says yes. The government says no. The BOJ feels the time is ripe to do away with the policy of “quantitative easing.” The govern- ment feels it is premature to do so. Dueling time is here again over the conduct of monetary policy.
The quantitative easing policy has been in operation since March 2001. This is a long time for such an extraordinary policy measure to have been in place. It is extraordinary because it has rendered interest rates dysfunctional.
By flooding the private-sector banks’ reserve accounts with surplus cash, the BOJ effectively drove them away from the money markets. With cash being generously provided by the central bank, what need was there for banks to tap the money markets for still more extra cash? Money markets are the place where short-term interest rates are supposed to be determined. But if there are no participants in those markets, by definition there is nothing there to determine.
Accordingly, interest rates ceased to be a part of the monetary equation. Nothing could be more bizarre. The Bank of Japan is right to want to bring such a theater of the absurd to a close at the earliest possible opportunity.
Absurdity is all very well as theater, but it can be very detrimental to the health of an economy. Indeed, quantitative easing has reached a stage where it could turn into more of liability in the Japanese economy’s journey back to full health. On the face of it, the economy seems finally to be getting back into shape in a big way. The stock market is up, profits are up, business sentiment is up, and even salaries look as though they will start to rise in the upcoming spring wage negotiations.
Yet it has to be remembered that all of this is happening from a much enfeebled starting point. Take the case of a person who has been very ill for a long time finally being discharged from hospital. The question still remains whether he can lead a fully functional life in the outside world. Indeed, the discharge itself remains provisional in character — look carefully and you’ll that find the patient is still hooked up to the life-support system. For Japan, that life-support system is in fact the quantitative easing policy.
To the extent that this policy remains in place, one cannot really determine whether or not the economy is sufficiently well recovered to function properly under normal circumstances. A market economy in which interest rates have no role to play is not a market economy. The true test of the economy’s state of health will come when interest rates start moving again. Pushing that moment of truth further and further away into the future is no way for a sensible medical team to behave.
Admittedly, it may not be easy to remove the life-support system without an initial shock wave of high interest rates. That is where the medical team’s skill will be tested. The BOJ is only too aware of this.
That is why BOJ Gov. Toshihiko Fukui makes the point of saying that once the quantitative easing framework is gone, what will be left will be zero interest rates. This is his way of conveying the message that the procedure for removing life support will be carefully orchestrated to avoid a hard landing.
The government likes to say that it and the BOJ should be in accord on economic management. Very true. But accord is a two-way street. There are times when the government needs to think about being in accord with the BOJ, rather than the other way round.