GUATEMALA CITY – The collapse of Japan’s “bubble economy” at the end of the 1980s was followed by slumping prices that were thought to be evidence of persistent price deflation. As such, the Bank of Japan embarked on an adventurous path that involved introducing new, unconventional monetary policy tools. These included quantitative easing by purchasing government bonds without repurchase agreements and direct purchase of corporate bonds or commercial paper to flood markets with new money.
Most of the policy initiatives of the BOJ were to engineer low interest rates, but they also supported an ongoing obsession of Japan’s policy makers with foreign exchange valuations. Meanwhile, payments on existing reserves held by commercial holds were set at 0.1 percent. And the rate on required reserves to zero is minus 0.1 percent on excess reserves.
It is bad enough that commercial banks receive negative nominal interest rates for their deposits with the BOJ. Now, buyers of Japanese government bonds (JGBs) are offered the same bad deal. Japan’s 20-year government bond has sold with yields of minus 0.005 percent and 10-year Japanese bonds also hit a record low of minus 0.275 percent. Meanwhile, yields on 30-year JGBs breached 0.015 percent.
On the one hand, lower borrowing costs supposedly encourage households and businesses to spend more, boosting overall demand. On the other hand, lower interest rates were supposed to reduce demand for the yen and weaken it. A strong yen is perennially blamed for putting a squeeze on Japanese corporate profits by reducing the value of their overseas earnings.
Any objective evaluation of BOJ policies points to failure on both counts.
First, economic growth remains far below Japan’s previous long-term trend. Ultra-low interest rates paid on bank deposits have cost Japanese households trillions of yen in foregone interest income.
Unsurprisingly, this unwelcome burden on households undermined consumer spending, doing little to encourage new corporate investment. What occurred was an increase in the public-sector debt-to-GDP ratio to 250 percent and the total debt-to-GDP (including business, households and the financial sector) to rise to 600 percent of GDP.
While artificially cheap credit sparked much more debt, weak consumer spending and a lack of business investment brought muted economic growth rates. According to the Cabinet Office, the quarterly report for June 2016 shows GDP growth at 0.2 percent. For the period 1980 until 2016, the average GDP growth rate was 0.48 percent, with a high of 3.20 percent in the second quarter of 1990 and a low of minus 4.10 percent in the first quarter of 2009. Now, Japan’s real GDP is lower than in early 2013.
While failing to spark robust growth, BOJ monetary policies created conditions for misallocation of capital resources. As it is, low interest rates allowed more government spending to support inefficient companies and on wasteful public works projects that put fiscal drag on the economy. Over the past decade, public-sector expenditures driven by political expediency exceeded ¥100 trillion (about $1 trillion).
Second, attempts by the BOJ to curb the yen’s gains against the dollar have largely been offset by asset purchases by its American counterpart that tend to weaken the dollar. And so, the yen gained about 15 percent over the past year.
Part of the cause of persistent low growth is that keeping the BOJ’s call rate close to zero contributed to the formation of a pool of “idle funds” that hinders the operation of financial markets. Instead of promoting real economic growth, zero-interest rates make the money market unattractive since the cost of trading exceeds available yields.
It turns out the central bankers in the United States and Japan are building a massive Ponzi scheme where they buy bonds issued by their governments to hold interest rates down. For its part, the BOJ has been buying bonds worth ¥80 trillion ($786 billion) worth of government bonds a year. It now holds about a third of outstanding JGBs, a figure that could rise to 60 percent by the end of 2018. In turn, the value of total assets on the balance sheet of the BOJ is now almost 50 percent of Japan’s national income or more than double the same ratio for it counterpart in the U.S.
In the end, inflating the money supply to make credit cheap and drive up consumer prices reflects a misunderstanding of what is behind the persistent price decline. The reality is that financial and corporate sectors with failed investments continue to burden the economy with excess capacity and high inventories.
Artificially cheap credit and fresh flows of liquidity perpetuate distortions in the economy. First, they allow weak banks and inefficient firms to survive on life support. Second, policy makers and politicians can avoid tough decisions to reform Japan’s economy because ultra-low interest rates paid on newly issued debt allow them to borrow more and more. As it is, Tokyo is borrowing more than ¥40 for every ¥100 it spends.
The impact of ultra-loose monetary policy is not limited to domestic markets. It also finds its way into global markets through the so-called carry trade. Vast amounts of yen-denominated funds have been raised by borrowing at near-zero interest rates to be reinvested in instruments denominated in other currencies with higher yields. Holding such positions involves risks from obligations and expected receipts being in different currencies that may experience unpredictable swings.
As it is, lower interest rates are unlikely to increase lending or stimulate the economy if companies face restructuring that makes them unable or unwilling to undertake new investments. In all events, borrowing decisions by firms are guided by the availability of viable investment opportunities more than by current interest rates.
Up to now, the policy responses to Japan’s economic malaise have been oriented toward macroeconomic conditions. A better growth-oriented approach would focus upon microeconomic initiatives with a policy shift toward more capital-friendly arrangements. To this end, steps should be taken to increase both domestic and international competition through deregulation and lowering the overall tax burden along with reforms of the pension system.
Recovery of growth in Japan’s real economy requires that monetary policy be changed so interest rates can begin playing their normal role as a rationing device. Central bankers’ “central planning” of the financial sector with controlled prices for credit are failing for the same reason as central planners of communist economies failed. It is time to recognize this and allow financial markets to determine interest rates to guide economic growth.
Christopher Lingle is a research scholar at the Center for Civil Society in New Delhi and a visiting professor of economics at Universidad Francisco Marroquín in Guatemala.
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