Rebooting Abenomics: Quick BOJ Thoughts

Abenomics was always supposed to have three arrows: monetary easing, fiscal stimulus, structural reform.

In reality, it’s been several volleys worth of the first type of arrow, a few goes at the second and not a great deal of the third.

Market fears leading into today’s Bank of Japan meeting centred over whether Kuroda’s quiver was nearly empty. As usual, he’s been keen today to emphasise that it isn’t.

There are two new elements in today’s package which taken together (providing the government follows through) may be worth more than the sum of their parts.

First — what Robin Harding at the FT — regards as a big deal, a commitment to overshoot their inflation target.

The Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds the price stability target of 2 percent and stays above the target in a stable manner.

The BOJ has become the first major central bank to follow the logic of macro theory and to pledge to overshoot it’s target. If this promise is taken to be credible then as Harding explains:

it should raise public expectations of the price level in the future. That, in turn, should lower real interest rates and stimulate the economy because loans will be paid back in a devalued currency.

Of course a pledge to overshoot a target that the BOJ has consistently failed to even hit isn’t necessarily credible. By itself, I don’t see this sort of talk achieving a great deal — except in as much as emphasising to the market that fears that the BOJ was nearing the end of the easing road are over-done.

The second innovation today is the most interesting:

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent).

The Bank is now explicitly targeting both long term and short term rates.

At this point, I think it’s fair to say that the net delineation between “monetary policy” and “government debt management policy” in Japan has become blurred.

The usual historical precedent people reach for here is the monetary/fiscal policy co-ordination in the US post-war and during Operation Twist. But I find myself thinking about the UK’s post war experience. This line from a BIS paper feels rather familiar today:

The period 1945–47 was one in which debt management policy was indistinguishable from monetary policy, and the structure of interest rates throughout the yield curve was managed as a single enterprise. Moreover the criteria for determining interest rates were clearly articulated.*

But whilst the UK attempted to control the curve against a backdrop of inflationary pressure that isn't currently the case in Japan.

Put today’s two monetary innovations together and you come to what may be the most important line in today’s report:

The Bank believes that its monetary policy and the Government’s fiscal policy as well as initiatives for strengthening Japan’s growth potential will produce synergy effects, and thereby will navigate Japan’s economy toward overcoming deflation and achieving sustainable growth

The BOJ is effectively pledging to hold ten year borrowing costs at around zero (the yield curve target) and to do this for quite some time (the inflation overshoot pledge). That is a strong signal that the government should follow through with fiscal stimulus — stimulus that effectively comes with no borrowing costs.

It’s not quite a monetary financing but it’s a step closer.

A pledge to overshoot a target you’ve consistently failed to hit isn’t especially credible. The macro impact of that pledge through expectations is unlikely to be large. But a pledge to finance government spending at zero per cent for the coming years could be a much bigger deal — even if it is only making explciit what has been implicit in Japan for quite some time.