BOJ revives 'zero-interest-rate' policy

Board resorts to quantitative easing in attempt to stem deflationary trend

The Bank of Japan decided Monday to effectively revive the “zero-interest-rate” policy, only seven months after abandoning it, as it tries anew to get a hold on the nation’s faltering economy.

The BOJ said it will raise the target balance for commercial bank reserves at the central bank to 5 trillion yen from 4 trillion yen through a policy of quantitative easing, which is expected to bring the overnight call rate down toward zero by increasing the amount of money in the market.

The overnight call rate is the interest rate charged by banks when making short-term loans to one other.

The new approach marks the first time quantitative easing has been used in Japan.

The BOJ said it will keep the policy in place until the consumer price index, which is currently negative, stabilizes at no lower than zero percent from the previous year, meaning until deflation has stopped.

The central bank also said it will increase its outright purchases of long-term government bonds in the market, thereby increasing liquidity.

BOJ Gov. Masaru Hayami said the bank may even consider a further loosening of monetary policy by raising the target reserve balance at future Policy Board meetings, depending on the economic situation.

“Japan’s economy has failed to return to a sustainable growth track and is now faced again with a threat of deterioration,” the BOJ said in a statement released after the closely watched Policy Board meeting.

The situation required “monetary easing as drastic as is unlikely,” it said.

The decision by the nine-member panel follows a week of plunging share prices worldwide sent tumbling by the meltdown on Wall Street, which pulled Tokyo’s key Nikkei 225 Index to new postbubble lows.

The move is the BOJ’s third consecutive easing since January and is widely taken as an admission that the central bank’s scenario for a gradual recovery has been knocked off course.

Hayami had repeatedly ruled out a return to the zero-interest-rate policy, stating that the actions go against market principles and should be reserved only for emergency situations. The Policy Board for the most part supported him by cautioning against quantitative easing, since its effects can not be predicted.

But at Monday’s news conference, Hayami said, “There were limits to what we could do with the (previous) zero-interest-rate policy of fixing the overnight call rate at near zero.

“Quantitative easing means that when the pressure for funds rises, interest rates will rise and also reflect the credit risk (of financial institutions), and when necessary, (the BOJ) will provide more funds,” he said.

When the BOJ scrapped its 18-month experiment with near-zero rates in August, it declared that the economy had substantially improved. The decision of the Policy Board, led by Hayami, was made despite acute political pressure that even involved a motion by government observers to postpone the vote until the following month. The motion was overruled.

“At present, Japan’s economy is showing clearer signs of recovery, and this gradual upturn, led mainly by business-fixed investment, is likely to continue,” Hayami said at the time. “(The) Bank of Japan feels confident that Japan’s economy has reached the stage where deflationary concern has been dispelled — the condition for lifting the ‘zero-interest-rate’ policy.”

That was seven months ago.

In a news conference Monday, Hayami said that lifting the zero-rate policy in August was not a mistake because recent overseas factors have contributed to the current economic slowdown.

Unlike in February 1999, when the policy was introduced to ward off imminent financial collapse, market principles will be allowed to work on interest rates, Hayami said.

“This time, we’re looking at a forward-looking crisis. We want to support further structural reform (in the banking sector) by easing money,” he said.

Last week, the Cabinet Office downgraded its overall evaluation of the economy for the second consecutive month, saying the nation was in a state of mild deflation and that the recovery had apparently stalled on weak production stemming from the U.S. economic slowdown.

Industrial production fell 4.2 percent in January compared with the previous month, with machinery orders, a gauge of future capital expenditures, falling 11.8 percent and exports shrinking 5.1 percent.

Observers of the central bank were not surprised by Monday’s decision.

The return to the zero-rate policy had been expected after the central bank decided Feb. 9 to lower its official discount rate — the rate at which the BOJ provides short-term funds to banks — from 0.5 percent to 0.35 percent.

It then cut both the official discount rate and its more closely watched overnight call rate to 0.25 and 0.15 percent, respectively on Feb. 28.

Differing reactions

The BOJ’s decision Monday to return to the “zero-interest-rate” policy drew mixed reactions from government officials and private economists.

Akio Makabe, chief economist at Dai-Ichi Kangyo Research Institute, said, “The impact of the decision on the actual economy will be limited . . . although it will serve to prop up share prices.”

Makabe praised the central bank for linking the monetary easing measure to a target consumer price index.

“The (previous zero-interest policy) was worded too vaguely. This is clearer,” he said.

Ryutaro Kono, chief economist at BNP Paribas, cast doubt on the effects the easing would have on the economy. “The reason low interest rates don’t work in Japan is because fundamental disposal of banks’ bad debts is not complete,” Kono said.

The BOJ had been hinting that progress in corporate restructuring and clearing banks’ balance sheets of bad loans were preconditions for further monetary easing. The pressure on the central bank, however, proved too great.

“The BOJ didn’t have a choice. They couldn’t wait,” Makabe said.

Finance Minister Kiichi Miyazawa on Monday welcomed the BOJ’s decision.

“It is significant the BOJ has taken all possible measures,” he told reporters, adding the latest steps will help bring Japan out of a state of deflation.

But now that the central bank has done all that was expected of it, he said, it is the government’s turn to act.

“We will come under greater pressure to work out details of economic measures proposed by the ruling parties,” he said, referring to an economic package recently put together by the ruling coalition to firm up the sagging stock market.

But Miyazawa was quick to add that the government has no plans at the moment to consider drafting an extra budget or additional fiscal policy actions.

He also said he will carefully monitor the effect of the BOJ’s monetary easing on the currency market but that he has no particular steps in mind.

Chief Cabinet Secretary Yasuo Fukuda praised the BOJ for effectively reviving the zero-interest-rate policy.

“I hope that the BOJ’s decision will have a good effect (on the economy) given the current overall situation,” Fukuda said. “Today’s decision was a good one.”

Concerning the BOJ’s decision to scrap the policy in August, Fukuda said, “That was the correct decision, all things considered . . . I want to believe that the BOJ makes its decision based on the overall economic situation.”