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Dissecting the Bank of Japan's zero-rate policy 20 years on

by Brett Miller and Toru Fujioka

Bloomberg

Long before the U.S. and Europe embraced radical monetary policies last decade during the global financial crisis there was the Bank of Japan.

Twenty years ago this month — back when the American economy was running hot under Federal Reserve Chairman Alan Greenspan and the euro was making its debut on the world stage — the BOJ adopted zero interest rates, taking central banking into uncharted waters.

Barely two years later, while benchmark rates in the U.S. and Europe were around 5 percent, it doubled down with a quantitative easing program to flood the banking system with cash. The BOJ’s strategies were seen as both extreme and peculiar to Japan — that is until the 2008 financial markets conflagration and resulting economic contractions forced the Federal Reserve and the European Central Bank down similar paths.

Fast forward to 2019 and the Fed is normalizing policy while the ECB is laying the groundwork to do the same. Despite moving first, the BOJ finds itself the outlier again, locked into an even more radical negative-rate regime and asset purchases of bonds, stocks and property trusts that dwarf anything attempted elsewhere.

Japan’s 20-year experience shows the limits of what central banks can do on their own and underscores the importance of broader economic reform and fiscal policy that dovetails with monetary programs. Perhaps the most pertinent lesson for the Fed and ECB is the danger of reversing course too soon.

“Monetary policy can buy time but it doesn’t solve all the problems,” said Kenji Yumoto, who helped run Prime Minister Keizo Obuchi’s economic advisory panel in 1999 and is now vice chairman of the Japan Research Institute.

Ben Bernanke, whose academic work drew many lessons from Japan, was among the BOJ’s critics back in the 1990s for its “self-induced paralysis” and lack of “Rooseveltian resolve.” He turned far more sympathetic after his stint as Fed chairman through the financial crisis.

Inside the BOJ, there was huge concern about making the fateful cut in benchmark rates. Yasuo Gotoh told fellow board members that it felt as if they were “stepping into a fairy tale like ‘Alice in Wonderland.'” Eiko Shinotsuka, who cast the one dissenting vote, later recalled that the board didn’t know how things would turn out, but felt it had no choice.

The pressure was palpable on the morning of Feb. 12, 1999, as Gov. Masaru Hayami led the debate on the matter. Markets were reeling as yields on Japan’s benchmark 10-year bonds more than doubled in the space of three months and the yen surged more than 20 percent from an eight-year low in August the year before.

In a rare move then, four government officials including the economy minister attended the meeting. They didn’t participate directly in the discussions but behind the scenes politicians had been lobbying Hayami to act. One even asked the governor why the BOJ couldn’t underwrite government debt or buy massive amounts of bonds.

The board took the plunge and the zero rates era began.

But just a year and a half later it increased rates to 0.25 percent. The timing proved to be poor: the dot-com boom went bust and pulled Japan down with it in 2001, forcing a reversion back to zero and the addition of quantitative easing. It stuck with such settings for the next five years.

Then came the decision to try to normalize policy in 2006 as the economy picked up and consumer prices rose slightly. But again, global clouds gathered on the horizon. As the financial crisis unfolded around the world and the Fed led the way out with decisive action, Japan mostly muddled along until Haruhiko Kuroda took the reins at the BOJ in 2013 and amped up its stimulus program.

A fundamental problem for the BOJ — then and now — is that policies such as zero or negative rates and quantitative easing were never supposed to run as long as they have. They’re meant to jolt households and companies to borrow, spend and invest, spurring prices to rise, the economy to perk up and then allow the central bank to wind back the stimulus.

“We never thought QE and zero-rate policy would be inflationary,” said Rob Subbaraman, who was with Lehman Brothers in Japan at the time. Subbaraman, now Nomura’s Asia ex-Japan chief economist in Singapore, says the private sector had no incentive to borrow, undermining whatever the BOJ did.

Instead, two decades of rock-bottom interest rates have hurt the nation of savers, who have responded by tightening their belts. Low-cost loans have propped up unprofitable companies while big business has piled into investing overseas as the market shrinks at home.

Those two decades of failure to reflate the economy have created a whole generation of consumers with little understanding or expectation of rising prices, complicating Kuroda’s efforts even further. Banks and debt markets have been caught in the crossfire, with negative rates crushing the profit margin on lending and the BOJ’s massive asset buying under quantitative easing sucking the life out of bond trading.

While it’s hard to call the world’s greatest monetary experiment a success, it’s also clear things would have been far worse without it. The BOJ has got the better of deflation, even if the consumer price index dips into the red briefly in 2019 because of low oil prices and one-off changes in phone and education costs. And instead of economic malaise, Japan has enjoyed a modest expansion in recent years, with unemployment near the lowest since 1992 and wage growth, though tepid, still the best in many years.

The country has achieved all this despite an ill-timed tax increase in 2014, a slowdown in economic reform efforts by Shinzo Abe’s government and unprecedented demographic headwinds. Japan’s population continues to fall and one in three people are now age 60 or older.

Bloomberg Economics’ Yuki Masujima is among those who argue that despite its many failings, Japan on balance has benefited from the adoption of unorthodox monetary policy.

“It was a choice — slow death or risky but powerful treatment,” said Masujima. He sees the challenge now in the diminishing returns of policy, even after the stepped up aggression under Kuroda, while negative side effects keep accumulating.

“Sooner or later the break-even point will come,” said Masujima. “But it’s much easier to introduce policy than it is to exit.”