Under the direction of Haruhiko Kuroda and the Policy Board, every week dozens of Bank of Japan employees work to supply liquidity to the Japanese financial system to the tune of billions of yen.
This process — considered by some to be the largest monetary experiment in modern history — has continued unabated for five years with one single-minded goal: to break out of the deflation Japan has flirted with for the past two decades.
While experts are still deeply split over the merits of Kuroda’s insistence on reaching 2 percent inflation by almost any means, there appears to be a consensus on at least one issue: his second term will be much tougher than the first. He is likely to be caught between the fear of side effects of his ultra-loose monetary policy and pressure from politicians to keep pumping stimulus into the still-fragile economy to provide ultra-low interest rates and more fiscal spending.
Kuroda “has already used up almost all of his ammunition. His second term will be much tougher than the first one because he still needs to keep fighting,” said Takahide Kiuchi, a former member of the BOJ Policy Board who is now an executive economist at Nomura Research Institute.
With the aim of finally beating deflation, the BOJ began buying massive amounts of Japanese government bonds in 2013, when Kuroda announced that the central bank would keep buying government bonds so that the amount it held of outstanding JGB would increase by as much as ¥50 trillion each year. Kuroda would later double down on the policy, shocking markets in 2014 by raising the annual goal to ¥80 trillion.
After almost five years of this policy, market observers like Kiuchi have grown particularly concerned about its sustainability as there are a shrinking number of bonds available.
According to figures from the BOJ and the Finance Ministry, the central bank now holds almost 46 percent of all outstanding JGBs.
“If the BOJ keeps buying JGBs to the utmost limit, liquidity will become low and the interest rates for government bonds would become very unstable,” said Kiuchi, who served as a board member from July 2012 to last July.
If only small amounts of JGBs are left on the market, even a small shock could easily trigger a spike in long-term interest rates. Such shocks may come from market participants’ concerns over the fiscal sustainability of the debt-ridden Japanese government, Kiuchi explained.
In an apparent response to these concerns, in September 2016, Kuroda introduced a new policy called “yield curve control” in which the BOJ buys bonds in varying degrees with the goal of keeping the 10-year JGB at close to zero percent. The new policy helped the central bank reduce the pace of its purchases to around 50 trillion a year, which has pushed back the expected time limit for the massive bond-buying operation by several years.
Fiscal experts, meanwhile, have raised concerns over Kuroda’s monetary easing, pointing out that the resulting long-term interest rates have allowed the central government to keep issuing massive amounts of bonds at an extremely low cost.
With rock-bottom rates, there is little incentive for the government to reduce fiscal spending despite its snowballing debts, which already exceed 250 percent of gross domestic product — by far the highest level among developed countries.
Prime Minister Shinzo Abe’s government appears reluctant to unwind the program and reduce fiscal spending.
On Feb. 16, Abe nominated Masazumi Wakatabe, professor of economics at Waseda University in Tokyo, to act as BOJ vice governor under Kuroda. Wakatabe is well-known as an advocate of aggressive monetary easing and huge fiscal spending.
In his article in the December issue of monthly economic magazine Gekkan Shihon Shijo, Wakatabe opposed raising taxes and instead called for drastic fiscal spending in a wide range of areas ranging from social infrastructure, education and science to defense and poverty mitigation.
“If you are worried about fiscal reconstruction, it could rather derail (efforts) to break away from deflation and achieve economic revitalization,” Wakatabe wrote.
The split is clear between those who worry about the side effects of easing, and those who support Kuroda’s easing as a means to break away from deflation before all other considerations.
For the backers of Kuroda and monetary easing at least one fact is on their side. Despite repeated warnings from so-called alarmists that financial conditions could sour, including a spike in long-term interest rates, the worst predictions have yet to materialize over the past five years.
“Kuroda has done a good job, even though the 2 percent (inflation target) has not been reached,” said Masahiro Kawai, professor of economics at the Graduate School of Public Policy of the University of Tokyo.
Kawai said that achieving inflation is worth the risk in order to jump-start the economy.
“If prices continue to decline, that will kill people’s animal spirits. In other words, people do not invest, do not consume and the economy continues to stagnate,” he said.
Kawai believes targeting 2 percent inflation is important because the central banks of many other advanced economies, including the U.S. Federal Reserve Board, European Central Bank and Bank of England, have maintained the same target.
He also pointed out that Kuroda’s monetary easing has helped lower the yen’s value against the dollar, which has greatly benefited export-driven firms and sent stock prices far higher than they were before the program began.
“If the BOJ settles for a lower inflation rate, there would be continuous upward pressure on the yen, which is itself deflationary,” he said in an interview.
This same pressure, seen at its most extreme in 2012, badly plagued Japanese exporters and was one of the key factors that prompted Abe to advocate massive monetary easing.
Sayuri Shirai, a BOJ Policy Board member from April 2011 to March 2016 who is now a professor of economics at Keio University, said in a recent interview with The Japan Times that one of the original — though unofficial — goals of the BOJ’s monetary easing was to correct excessive appreciation of the yen. The BOJ has never officially admitted this.
In fall 2012, the dollar was trading at around ¥78 and the Nikkei stock average was hovering around 8,900.
But from 2010, the Group of 20 countries including Japan, China and the United States agreed that members should not devalue because it could trigger “a currency war.” This constrained Japanese policymakers from devaluing the yen.
“The BOJ was facing severe criticism in Japan and from abroad for its unwillingness to take aggressive monetary easing as compared with the Fed. The BOJ had also already lost credibility because of the failure to overcome the mild deflation,” she said.
“Thus the BOJ had to try everything it could do, and doing nothing was impossible,” Shirai recalled.
“Of course fighting deflation was one of the main aims, but coping with the yen’s appreciation was also a consideration,” she said.
Kuroda originally set an ambitious goal of stoking 2 percent inflation within two years, but prices barely budged. This has forced the BOJ to push back its timeline six separate times. The self-imposed deadline for reaching the inflation target is now “around fiscal 2019.”
Kuroda initially declared he would spark inflation by doubling the monetary base, or the sum of cash in circulation plus banks’ current account balances at the BOJ — through purchases of JGBs and other financial assets.
But Japan’s money stock — the total amount of monetary assets available in an economy excluding deposits held by financial institutions and the central government — has only increased slightly over the past five years.
In other words, banks have been depositing most of the massive funds provided by the BOJ into their own accounts at the central bank, limiting its effect on the real economy.
Daiju Aoki, chief economist at UBS Securities Japan Co., posits that the massive amount of liquidity put to the system has not reached the economy because companies themselves have not shown interest in loaning out money or spending more themselves. “The companies’ savings rate is still positive, and they are increasing savings rather than spending,” he said.
“Market participants don’t fully trust Kuroda because we haven’t seen 2 percent inflation after five years when he promised it would be achieved in two years,” said Keiko Onogi, a senior JGB strategist at Daiwa Securities Co.
“But if you ask these same market participants who they want for the next governor, almost all will say they want Kuroda to serve another term,” she said.
Shirai of Keio University maintained that the BOJ cannot keep propping up the economy forever with its radical monetary easing policy. Eventually the financial markets should be market-driven without the BOJ’s involvement, but still many Japanese firms and the public have not yet realized that, she said.
“The BOJ has kept interest rates at abnormally low levels and supported stock prices, generating undervaluation of the yen’s value. If it starts unwinding its monetary easing, everything will be reversed,” warned Shirai.
“The Japanese public and firms should brace themselves for falling stock prices, a spike in interest rates and a rise in the yen’s value. But I don’t think either of them are ready for it,” she said.
Kawai counters that “sharp upward pressure on JGB long-term yield will likely to be prevented as long as the government makes a commitment to fiscal consolidation.” But with Abe at the helm, and after five years of easing, taking the pedal off the monetary and fiscal stimulus may be easier said than done.
Timeline of monetary-easing events under Kuroda
April 4, 2013
The first round of quantitative easing under Kuroda aimed to purchase around ¥50 trillion in Japanese government bonds annually. Since the market had already sufficiently priced-in the expected easing policy after the official BOJ policy announcement, the exchange rate remained largely unchanged at around ¥100 to the dollar. While interest rates on bonds under 20 years fell, bond yields over 30 years rose — steepening the yield curve.
Oct. 31, 2014
Kuroda shocked markets by increasing JGB purchases to ¥80 trillion annually, targeting longer term maturity bonds (as long as 10 years, up from the prior average of seven years) as well as tripling both purchases of exchange traded funds (ETFs) and real estate investment trusts (REITs) to ¥3 trillion and ¥90 billion, respectively. The yen weakened significantly against the dollar, with bond yields under 10 years continuing to move toward zero.
Dec. 18, 2015
The BOJ opted to keep bond purchase amounts unchanged, making one minor tweak to policy by targeting longer term maturity bonds to as long as 12 years.
Jan. 29, 2016
Despite initially showing little appetite for negative interest rates, Kuroda surprised the market once again by introducing negative interest rates on select bank reserves. In the week after the announcement the Nikkei index slumped, and — contrary to expectations — the yen strengthened against the dollar.
July 29, 2016
ETF purchases were increased from ¥3 trillion to ¥6 trillion, an underwhelming decision for markets which saw lower stock prices and higher JGB bond yields in the immediate aftermath.
Sept. 21, 2016
The BOJ changed tactics once again, adopting a “yield curve control” framework in which the 10-year rate is targeted at zero percent. This allows for the bank to make purchases on a flexible basis, rather than simply increasing JGB purchases by a set amount. The yield curve continued to flatten, with the longest term bond (40 year) yields dipping below 1 percent.
Dec. 31, 2017
After five years of asset purchases, the BOJ owned by the end of 2017 around ¥440 trillion in JGBs — or around 46 percent of the JGB market. Despite the Nikkei reaching 22,2764 — up from 12,1888 when the easing began — and the yen remaining relatively weak at ¥112 to the dollar, inflation, including for energy and fresh food, has remained under 1 percent.