The government of Japan downgrades its forecasts on GDP growth and inflation for the coming years. This evidences the failure of the transmission mechanism of the monetary policy adopted by the Bank of Japan. We believe the central bank has already run out of solutions to rescue sluggish economic growth and disinflation. At the upcoming meeting, it would reiterate the exceptional accommodative monetary policy stance, with the key policy focus on yield curve control.

Government Downgrades Economic Outlook

The Cabinet Office announced that the GDP growth forecast for fiscal 2018 (year ending in March 2019) is revised lower to +0.9%, compared with the previous projection of +1.5%. Growth for fiscal 2019 is also trimmed to +1.3%, from previous estimate of +1.5%.

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Concerning the components, capital expenditure is expected to expand +2.7%, compared with previous estimate of +3.4%, amid global economic growth slowdown. Growth in private consumption is unrevised at +1.2%, as the impact of a consumption tax hike scheduled in October would be offset by fiscal stimulus.

The government, however, remains upbeat on exports, expecting growth of +3% despite US-China trade war.

On inflation, CPI are revised lower to +1% (previous: +1.1%) and +1.1% (previous: +1.5%) for fiscal 2018 and 2019 respectively.

 

Brief Review of BOJ Monetary Policy after 2007/08 Global Financial Crisis

BOJ has kept the policy rate around 0% since late 1990s, as the country’s economy has been suffering from stagnation after the burst of asset bubbles in 1991-92. As such, rate cut, although the central bank had done so, is not a feasible policy tool for BOJ to stimulate the economy in the outbreak of the 2007/08 Global Financial Crisis.

QE, while it appeared unconventional in the policy by the Fed or the ECB, had been adopted by BOJ from 2001-2006. The severity of the global financial crisis, however, had called for a return to QE in January 2009.

In April 2013, BOJ introduced a tool called qualitative and quantitative easing (QQE). While the quantitative part is asset purchases (JGB purchases at a pace of 80 trillion yen/ year), the qualitative part is and inflation-overshooting commitment, under which BOJ continues expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2% and stays above the target in a stable manner.

Through this commitment, BOJ aims to enhance the credibility of achieving the price stability target of 2% among the public. QQE was then “enhanced” with negative interest rate (the policy rate has been staying at -0.1% to 0% since early 2016) and yield curve control (YCC) in 2016. In July 2018, the central bank tweaked the YCC measure modestly, allowing the yields to move in the range of +0.2% and – 0.2%, from previous range of +0.1% and -0.1%.

To summarize, BOJ’s existing monetary policy tools include keeping policy rate at -0.1%, purchasing JGBs at a pace of 80 trillion yen/ year and yield curve control -keeping 10-year JGB yield at 0%, with trading band at +0.2% and – 0.2%.

Miscommunication between BOJ and Market

The transmission mechanism is critical to the success of monetary policy. When a central bank lowers its policy rate, which is usually the short-term interest rate it charges on lending money to commercial banks, it aims at influencing the commercial banks to also lower their interest rates charged on loans to corporations and individuals. Eventually, asset prices and general economic conditions are affected as a result of the rate cut.

Therefore, a monetary decision intends to influence the aggregate demand, interest rates, and amounts of money and credit in the market. These would in turn influence the overall economic performance.

BOJ’s actions have from time to time been misread by the market. This problem has greatly affected the effectiveness of the policies it adopted.

For example, while BOJ has reiterated in every meeting statement that it would continue to buy JGBs at an annual pace of 80 trillion yen, the actual increase in BOJ’s holdings has been falling consistently since 4Q16. The annual increase fell to 58 trillion yen and below 40 trillion yen in December 2017 and November 2018, respectively.

No clarification was made by officials until speculations that BOJ had been tapering became so intense. A more clarification was made at a Bloomberg interview in October. Governor Haruhiko Kuroda admitted that the 80 trillion yen purchase is only a symbolic measure by now and the market should focus on YCC.

Another example is BOJ’s recent tweak on YCC, allowing the yields to move in the range of +0.2% and – 0.2%, from previous range of +0.1% and -0.1%. The one-way increase in yields suggests that the market interpreted the tweak as with tightening bias.

Attempting to downplay speculations on BOJ’s exit from stimulus measures, Kuroda noted at the above-mentioned interview that only a change in interest rate target would be a signal for policy shift. He added that interest rates would stay at the current level as inflation has stayed weak. JGB yields corrected after his words, together with expectations that the global rate hike cycle might end soon.

It is so obvious that BOJ would have to keep stimulus for an extended period of time, given economic stagnation and weak inflation. While BOJ has reiterated the accommodative policy stance, it appears ambivalent on how to implement the tools.

Unlike Fed and ECB, BOJ has been reserved, refraining from preemptive communication with the public on the policy measures unless tightening speculations have sent Japanese yen or bond yields soar to very high levels. Back in March, the yen jumped after Kuroda indicated that BOJ may find itself thinking about exiting its stimulus in the year starting in April 2019.

Over the past 20 years, Japan has lost competitiveness in exports to rivalries in China and South Korea. Elevated exchange rate due to yen’s role in carry trades has only exacerbated the problem. This is undoubtedly an arduous mission for BOJ to try to reverse the scenario.

Besides implementing the “innovative” measures trying to revive the economy, the central bank should also improve its communication with the market. This should facilitate the transmission mechanism and improve the effectiveness of its policies.

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