Sunday, March 4, 2012

Bank of Japan stuck in perpetual QE

The FT has a nice write-up by Edward Chancellor entitled "Japan catches the Bernanke religion". He points to deflationary pressures in Japan that are no longer driven by deleveraging of Japanese corporations.
So why has deflation persisted in Japan? Economist Kosuke Motani of the Development Bank of Japan blames the aging population. Since the mid-1990s, Japan’s workforce has contracted. Fewer workers have less money to spend. But supply has not shrunk at the same pace. This has put downward pressure on prices. “What is happening in Japan,” says Mr Motani, “is not deflation of all, but a collapse in the price of products consumed by the working age population.”

There is something to this story. Foreign investors are often exasperated at the excessive resources Japanese companies devote to a shrinking domestic market. Since hostile takeovers are rare, businesses are largely insulated from the pressure to cut supply in the face of falling demand. Monetary policy is no panacea. Governor Shirakawa has stressed the need for Japan’s economy to adapt and for zombie companies to be allowed to fail.
Combined with strong yen and real interest rates that are stubbornly positive (unlike in the US), the economic environment in Japan seems to require an almost perpetual program of quantitative easing. In trying to understand BOJ's strategy to address this deflationary environment, most analysts tend to look at the whole balance sheet of the central bank (which has a great deal of noise). The simplest way to view the trend of Japan's QE is to analyze BOJ's holdings of government bonds excluding short-term bills. BOJ seems to have a permanent policy of government bond purchases that would even make Bernanke jealous.

BOJ holdings of government bonds (source: BOJ)

Given Japan's structural issues, it is hard to imagine if even such an aggressive monetary stance could make a significant difference. BOJ may be hoping to achieve more accommodating real rates and possibly try to weaken the yen along the way (to boost exports). Some argue that given Japan's GDP, BOJ's balance sheet growth is still too low compared to the Fed's/ECB's, and the central bank could and should do more. But with domestic sources of energy permanently impaired since the tsunami disaster, weakening the yen may be counterproductive. Imports of expensive fuel, combined with stagnant salaries, may further dampen domestic spending. Nevertheless BOJ is determined to win its battle against deflation.
FT:  On February 14, however, the Bank of Japan put out a surprise statement clarifying its “determination to overcome deflation”. The bank announced a new “goal” of price stability, with the intention of delivering 1 per cent inflation in the near term. The central bank said it would increase the size of this year’s asset purchases by Y10tn ($123bn). Jaded Japan-watchers mocked this announcement. It was suggested the central bank had eschewed the adoption of a target because a goal was less binding. Others claimed asset purchases would be insufficient to dispel deflation.

Yet this move should not be dismissed lightly. The Bank of Japan has committed itself to further easing until its inflation goal is “in sight”. Now that deleveraging has abated, the central bank should have the power to change inflation expectations. For the first time in years Japan’s bond markets are no longer forecasting a fall in the price level. Among the swirling oceans of quantitative easing, Japan no longer remains an island of deflation.


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