Japan’s economy has been under severe stress since the consumption tax was increased last October, a situation only made worse by the COVID-19 crisis. After the economy fell by minus 7 percent on an annualized basis in the 2019 fourth quarter, further retrenchment is expected to continue until around the middle of 2020.
In April, the government presented a large economic package equivalent to about 20 percent of nominal GDP and includes private sector-related spending. However, the lack of electronic government that provides efficient public services with information and communication technologies has hampered timely, effective fiscal stimulus that targets the most-affected small and medium-size enterprises (SMEs) and individuals.
Meanwhile, monetary easing measures adopted by the Bank of Japan lack boldness compared with U.S. and European central banks. In March, the BOJ introduced a temporary liquidity operation to provide loans to banks at zero percent with a maturity of up to one year by mitigating collateral requirements, until September.
The interest rate was lowered by a mere 0.1 percent from those applied previously to other operations. In addition, the upper limit for purchases of corporate bonds and commercial paper was raised moderately by ¥2 trillion up to September 2020. The upper limit for the annual pace of stock exchange-traded funds (ETF) purchases was doubled for the time being.
The BOJ’s balance sheet has risen only 5 percent so far. The increase was mostly attributable to the rapid use of dollar-supplying operations, whose U.S. funds were borrowed from the Federal Reserve. As this is not an outcome of the BOJ’s monetary policy, the BOJ needed to add monetary easing at the end of April 2020.
The upper limit for purchases of corporate bonds and commercial paper was increased by another ¥10.6 trillion with the remaining maturity of corporate bonds purchased being extended by one to five years. The temporary liquidity operation accepted a wider range of collateral and small credit unions as counter-parties.
Nonetheless, the BOJ did not lower the policy rates (negative rate of minus 0.1 percent and the 10-year yield target of around zero percent). Since October, BOJ Gov. Haruhiko Kuroda has expressed the central bank’s willingness to lower policy rates if necessary. But lowering the policy rates would reduce the profitability of the financial sector, thereby discouraging banks from taking risks by increasing lending to affected SMEs.
Moreover, the BOJ did not provide interest subsidies to banks by paying them to borrow, contrary to the scheme unveiled by the ECB. The increase in net purchases of corporate bonds and commercial paper helps support large firms, but some large firms issue them for precautionary motives. Large firms hold substantial cash and deposits, amounting to half of nominal GDP.
The markets for corporate bonds and commercial paper are very small — just 11 percent of nominal GDP — relative to bank loans accounting for 60 percent of nominal GDP. Thus, such asset purchases will have limited impact on overall financial conditions. While ETF purchases help to prevent stock prices from falling persistently, they have only a small impact on household income since households’ stock holdings account for only 10 percent of financial assets.
In April, moreover, the BOJ decided to purchase Japanese government bonds and Treasury bills without limit — following the Federal Reserve — by eliminating “an annual pace of about ¥80 trillion” from the statement. By removing the specific purchase amount, the BOJ wanted to demonstrate that it is taking a bold approach. It is good to remove “¥80 trillion” since the purchase amount over the past three years has been well below this amount anyway. This action does not make any material difference from the previous framework.
If banks do not actively use the BOJ’s support, the BOJ may need to develop new measures targeting banks that extend loans to affected SMEs by paying banks to borrow and/or adopt a bank loan purchase scheme similar to the Main Street Lending Program adopted by the Federal Reserve together with the Treasury. Provided that little room is left for the BOJ to conduct bold monetary easing without taking greater risk, collaboration with the government, including a loss-sharing mechanism, might be necessary.
Sayuri Shirai is a professor of Keio University and a former Policy Board member of the Bank of Japan.