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Limits of central bank policy

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At its monetary Policy Board meeting on Jan. 29, the Bank of Japan decided to reduce the interest rate applied to current account deposits that commercial banks have at the central bank in excess of a certain amount from 0.1 percent to minus 0.1 percent, in addition to maintaining its large-scale easy money policy of increasing the monetary base by ¥80 trillion per year. The decision was made by a narrow margin, with five of the Policy Board members casting affirmative votes and four negative.

After the meeting, BOJ Gov. Haruhiko Kuroda told reporters that the decision was aimed at preventing the risk of the global market confusion spreading to Japan. If necessary, he said, the bank will reduce the interest rate further.

Negative interest rates had been introduced by the European Central Bank and the central banks of several European countries. But there are widely diversified views as to their effectiveness.

In Japan, commercial banks that have sold government bonds to the BOJ first deposit the money in their current accounts at the central bank. These deposits used to earn the banks some interest, though at a very low rate of 0.1 percent per year.

From now on, however, instead of receiving interest payments, the banks will have to pay fees, which may be called a penalty, of 0.1 percent per year for the money that has been newly deposited with the central bank.

This will lead the banks to refrain from increasing their current account deposits at the BOJ in order to avoid the penalty, and instead provide businesses with low-interest loans or consumers with low-interest housing loans in increased amounts or purchase corporate bonds and stock shares. Another alternative will be to invest in bonds denominated in foreign currencies. Any reasonable bank should follow these paths.

The question is whether the banks can find a sufficient number of low-risk borrowers. The reason why they have so far kept the money from the sale of government bonds in the BOJ current accounts even at the low interest rate of 0.1 percent is that it was not easy to find borrowers willing to pay interests higher than the 0.1 percent.

If the demand for money in the private sector remains sluggish, large amounts of money that the banks withdraw from the BOJ current accounts are certain to flow into stock and foreign bond markets, raising stock prices and reducing the value of the yen.

A general trend in the new year has been a fall in stock prices and a rise in the value of the yen. Putting the brakes on this trend was the primary purpose of the central bank’s decision to introduce the negative interest rate. Another aim was to shore up Prime Minister Shinzo Abe’s Abenomics economic policy, which appears to have been shaken by the Jan. 28 resignation of Akira Amari, minister in charge of economic revitalization and of economic and fiscal policy.

Indeed, following Kuroda’s press conference, stock prices sharply shot up and the value of the yen steeply fell. Until Jan. 28, the day before the central bank’s decision, the Nikkei 225 index, which stood at 19,033 points at the end of last year, plummeted to 16,011 points on Jan. 21 and thereafter remained volatile, moving below and above 17,000 points. Similarly, the exchange rate, which stood around ¥120 to the dollar at the end of December, shot up momentarily to below ¥116.

The yen’s rise beyond the expectations of export-oriented corporations and the tumbling of the stock market could adversely affect corporate balance sheets and pour cold water over the “virtuous cycle” envisaged by Abenomics.

The fact that the central bank’s decision to introduce the negative interest rate served to reverse the trend prevailing from the start of this year may have came as no surprise, yet was enough to prove the effectiveness of monetary policy.

Be that as it may, there is not any guarantee that Japan will achieve inflation of an annual rate of 2 percent by the first half of fiscal 2017, as has been targeted by Kuroda. Even if businesses agree to raise wages, as has been called for by the government, there is no guarantee that household spending will rise proportionately or that private housing investments or corporate capital investments will start showing significant upward movement.

According to most mass media reports, the stock market decline and the yen’s rise in early January were caused by China’s economic slowdown and falling oil prices. Since these factors follow their own logic that has nothing to do with what the BOJ does, it may be helpful to review causal sequences related to them.

China’s National Bureau of Statistics announced Jan. 19 that the country’s economic growth rate for 2015 fell to 6.9 percent, the lowest level in 25 years, clearly indicating a slowdown. This not only accelerated a downward movement in the Shanghai stock market but also immediately caused similar declines at the Japanese, American and European stock exchanges. The fall in the Shanghai market spread to other markets because manufacturing industry of Japan, North America and Europe heavily depends on exports to the Chinese market.

What sustained the global economy after the 2008 Lehman Brothers shock was China’s investment of 4 trillion yuan (about ¥60 trillion at the then-prevailing exchange rate).

This huge sum served to expand the supply capacity of both the manufacturing and service sectors of China more than needed. The slowdown of the Chinese economy is nothing other than a structural “recession” resulting from excessive production capacity and is likely to last for a long time.

If the Chinese economic slowdown does last a long time, it will deal a serious blow to Japanese, American and European manufacturing and service industries, which rely heavily on the Chinese market. This is the cause of the simultaneous plummeting of stock prices in many countries.

Falling oil prices may be regarded as a “gift from Heaven” for Japan, which has virtually no natural resources. Drops in the prices of gasoline, heating oil and diesel fuel should help households start spending more on goods and services, businesses make greater profits and the overall economy recover. Moreover, since the prices of other natural resources move together with oil prices, this should sharply reduce imports in value for resource-scarce Japan and boost its gross domestic product.

But the economic reality is not as simple as that, making discourse on economics difficult. Late in 1973, when crude oil prices shot up fourfold within three months, the Japanese economy appeared to be headed for a total collapse because the nation relied on imports for 99 percent of its oil needs. In fact, Japan’s GDP for fiscal 1974 recorded negative growth for the first time in the postwar period.

But as oil-producing countries benefited from price hikes, they sharply increased purchases of manufactured goods from Japan, which in turn enabled the Japanese economy to make a soft landing with an annual growth rate of between 4 percent and 5 percent.

Conversely, falling oil prices have had the effect of contracting the economies of oil-producing nations, reducing their import of manufactured products from Japan, North America and Europe. To make up for shrinking income from oil export, those countries have resorted to selling their precious securities assets in the Japanese, American and European stock markets.

For these reasons, the recent plunge of oil prices is now called a “reverse oil shock” and has become one of the causes of simultaneous declines of stock prices in a number of industrialized countries.

Two factors are cited for the fall in oil prices. One is the advent of shale oil production in North America, which consists of injecting high-pressure water into shale cracks. The cost of extracting shale oil is as high as $30 to $50 per barrel. If the depreciation cost of equipment is taken into account, the break-even point is said to come to $100 per barrel. Taking this cost factor into consideration, OPEC at its plenary meetings in 2014 and 2015 decided against reducing their oil production. This had an effect of sharply lowering market prices of crude oil from more than $100 to around $30 per barrel.

The second factor behind the falling oil prices is a decline in imports by China, the world’s second biggest oil consumer, due to its economic slowdown.

As seen above, the effect of domestic monetary policy could be immediately reduced to naught by highly unpredictable political and economic trends abroad.

Takamitsu Sawa is the president of Shiga University.