The Bank of Japan has decided to lift its quantitative easy-money policy, an emergency and unprecedented measure introduced five years ago to pump vast amounts of interest-free money into a stagnant economy plagued by falling prices. The much-heralded decision, made Thursday, opens the way for a return to the traditional method of monetary adjustment: the application of interest-rate functions.
The BOJ had set a number of conditions for reversing the easy-money policy, including stable above-zero increases in the Consumer Price Index. The CPI rose marginally for four consecutive months from October to January, and the bank expects the upward trend to continue. As such, the BOJ decision inspires confidence that deflation, which has dogged the economy for more than a decade, is finally coming to an end.
However, a strong belief persists, within the government and the ruling coalition, that the real economy has yet to overcome residual deflationary pressures. There is also concern that speculation over the future direction of monetary policy might cause excessive fluctuations in the market. For these reasons, the central bank has rightly put together a package of “market-stabilizing” measures.
Specifically, money-market rates on uncollateralized overnight interbank “call loans” — a target for interest-rate adjustment — will remain near zero for the time being. This “zero-interest rate” policy will effectively continue to provide a monetary prop for the economy.
Additionally, (1) purchases of long-term government bonds will be maintained at the current level of 1.2 trillion yen a month, and (2) the target balance of current-account deposits (interest-free cash reserves) with the central bank — which has been set at anywhere between roughly 30 trillion yen and 35 trillion yen — will be reduced in an “approximate period of several months.” In other words, the effects of “quantitative easing” will linger.
It is notable that, with the end of the ultraloose money policy, the BOJ has for the first time introduced a numerical target as a “benchmark” for policy management. This inflation reference sets the desirable medium- and long-term rate of increase in the CPI at zero to 2 percent vis-a-vis the year before.
This “price guideline” looks more like a product of compromise. The government and the ruling coalition had sought to have a more specific “inflation target” introduced, but the central bank was reluctant to do so. Still, it seems that the BOJ has come a little closer to the government side by proposing a more general price level in a form similar to that adopted by the European Central Bank.
That price level, described as an “understanding of medium- and long-term price stability,” will be reviewed every year in principle. It remains to be seen, though, how much the market will be able to “understand” the central bank’s policy intentions. Will the interest-rate policy remain unchanged for as long as consumer prices stay within the range of an inflation reference? What if market players and business enterprises are in doubt over how to interpret the guideline?
As a followup to the lifting of its easy-money policy, the BOJ is expected to nudge short-term interest rates upward sooner or later, although it says the zero-interest rate policy will be effectively maintained for the time being. This is a logical move given the consensus that deflation has all but ended. The market is already speculating about when the bank will allow interest rates to rise, and to what extent.
At a press conference following the decision to reverse the easy-money policy, BOJ Governor Toshihiko Fukui warned against letting a numerical target take on a life of its own, saying that how the central bank looks at medium- and long-term price trends is not always the same as its definition of inflation or the reference price level. The statement underscored the bank’s concern that setting such a target could limit its freedom of action at a time when inflationary expectations are rising, despite a stable price trend.
During the past five years, deflation has sapped the strength of both enterprises and households, and altered some of their structural characteristics. Now that there are growing signs of recovery in both sectors, it is essential to ensure that this favorable condition continues. For that to happen, the central bank needs to maintain a degree of continuity in its monetary policy.
With the decision to end the unprecedented ultraloose money policy, some financial institutions are already moving to raise interest rates on housing loans. What is required, therefore, of the BOJ in the coming weeks and months is a hands-on effort to send an easy-to-understand message about its intentions with regard to monetary policy.
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