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Top>Research>"Side Effects" of the BOJ's Monetary Policy


Masayoshi Tatebe

Masayoshi Tatebe [Profile]

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"Side Effects" of the BOJ's Monetary Policy

Masayoshi Tatebe
Professor of Finance, Banking and Monetary Policy, Faculty of Commerce, Chuo University

1. Successive strengthening of easy money policy

The Bank of Japan, at its Monetary Policy Committee monetary policy meeting in February and April 2012, with the aim of ending deflation, successively decided upon strengthening its easy money policy.

The contents of the February 14 decision surrounding the comprehensive monetary easing policy are as follows.

● For sustainable price stability and consistent inflation rates in the mid to long term, set the mid to long term price stability target. The BOJ's mid to long term price stability target has been determined at keeping consumer price inflation rates in the area of under 2% from the previous year and 1% for the time being.

● Aim for a 1% rise in consumer prices from the previous year, and until that can be achieved, promote strengthening of the easy money policy (clarification of policy duration effects) by implementing measures such as a substantial zero interest rate policy and financial asset purchases.

● Increase financial asset purchasing funds by 10 trillion yen from 55 trillion yen to 65 trillion yen (Starting at 35 trillion yen in October 2010 followed by gradual increases.) Long-term national bonds will be issued for financial asset purchases.

Also, the contents of the April 27 decision surrounding the comprehensive monetary easing policy are as follows.

● Increase asset purchasing funds by 5 trillion yen from 65 trillion yen to 70 trillion yen.

① Increase the purchase of long-term national bonds by 10 trillion yen (Taking into consideration the reduction in (2).)

② In regards to six month fixed-rate funds- supplying operation against pooled collateral (introduced in December 2009 and gradually expanded, this also constitutes part of financial asset purchases), taking into consideration the situation where the anticipated number of bids is not achieved, there will be a decrease of 5 trillion yen.

● In regards to the remaining period of long-term national bonds issued for purchasing, large sum purchasing, including this increase in cash, will be promoted, and from the viewpoint of effectively approaching longer term interest rates, the current '1-2 years' will be extended to '1-3 years'. The remaining period of corporate bonds issued for purchasing will be treated in the same manner as long-term national bonds.

2. Limitations of the comprehensive monetary easing policy

Resulting from the above, as of the end of June, current account balances held in the BOJ by financial organizations were the highest in history. This, or future BOJ comprehensive monetary easing policies, may be seen as quantitative easing and a fixed target with that effect. However, if you pay attention to BOJ Governor Masaaki Shirakawa, this policy is actually within the limits of traditional interest rate policies, and the dependence on those becomes clear.

Let's look at a few examples.

"We will promote interest rates as a base in our monetary policy, and this will exert influence on the economy as a whole. In regard to our current policy, it is often said to be an 'untraditional monetary policy'. It is true that we are undertaking untraditional monetary policies such as purchasing of CP, corporate bonds, ETF, and J-REIT, but the ripple effect mechanisms themselves are not necessarily untraditional, they are traditional mechanisms." (April 10, 2012 press conference)

"Previously, it was 'less than 2 years,' and this time we have changed to 'less than 3 years.' However, what is working such a zone is..when looking at the actual makeup of Japanese business capital procurement, a lot occurs in this zone. In the case of the US, there is more financial liability for family budgets than companies, and an overwhelming majority of that family budget borrowing lies in mortgages. Many mortgages are taken out for close to 30 years, and the average issuance term for many corporate bonds, a capital procurement method for companies, is an extremely long 13 or 14 years. In this type of financial structure, I believe it is effective to apply long-term interest rates, but in Japan there are not that many cases of long-term procurement. That is the reason why the Bank of Japan has traditionally acquired funds keeping 'less than 2 years' in mind." (April 27 press conference)

However, if that is to be the case, in the current comprehensive monetary easing policy of the BOJ, it must be said that the natural limits to the effects is a fact that is hard to deny.However, if that is to be the case, in the current comprehensive monetary easing policy of the BOJ, it must be said that the natural limits to the effects is a fact that is hard to deny.

The reasons for that are as follows.

First, implementing this policy may, indeed, slightly encourage the lowering of market interest rates for 'more than 2 years and less than 3 years'. However, that may also be expected to lead to a prominent increase in capital investment by companies, in other words, only enough to cover the forecast 15 trillion yen deflation gap. That is because, taking into consideration the interest rate term theory (the thinking that only risk premiums rise when comparing mid to long-term interest rates with short-term interest rates), it is certain that 'more than 2 years and less than 3 years' interest rates have already dropped to a suitable level. There is only the slightest margin for a decline in interest rates remaining.

Secondly, in the first place, monetary policy, as opposed to fiscal policy, cannot stimulate demand directly, and can only stimulate demand indirectly. That is to say, lowering of short-term operating target interest rates (ranging to longer-term market rates) by the BOJ→lowering of lending rates by commercial banks→increase in capital investments using bank loans by companies. In other words, by starting to rely on an increase in capital investment using bank loans by companies, monetary policy will only manifest the capacity to create demand. Accordingly, with the existence of a long-term deflation gap, the effects of monetary policy on the actual economy will conspicuously become a hindrance.

3. Side effects of strengthening easy money policy

With the BOJ's multiple money easing policies unable to conjure up any particular results, what has started to appear is the issue of side effects surfacing due to excessive monetary policies.

For now, I would like to point out the following two points.

Firstly, the Bank of Japan Financial Department's Financial Market Regulations of Fiscal Year 2011 state the following figures. "The Bank of Japan is conducting national bond purchasing operations in response to the current trend of banknote demand at a monthly pace of 1.8 trillion yen. Also, in regards to purchasing national bonds to manage funds, the upper purchase limit of 19 trillion yen as of the end of March 2012 was raised by 10 trillion yen at the monetary policy meeting held on April 27, 2012. Consequently, in order to raise the limit to 24 trillion yen by the end of 2012, and a final total of 29 trillion yen by the end of June 2013, we will conduct purchases at a pace of 2.1 trillion yen per month until the end of 2012, and 1 trillion yen per month from the start of 2013 until the completion of the raise in funds at the end of June." In short, there are two routes to purchasing long-term national bonds by the BOJ, 'national bond purchasing operations in response to the current trend of banknote demand' reaching 21.6 trillion yen for the year, and 'purchasing national bonds to manage funds' for 24 trillion yen from April 2012 until the of the year. Together, they represent a total of 45.6 trillion yen. This exceeds the 44.3 trillion yen of new revenue bonds issued by the government at the start of the 2012 fiscal year. That being the case, doesn't this mean that in this situation the BOJ has crossed the Rubicon and stepped into the realm of monetary finance? Or, to say the least, won't this play a role in inviting a relaxing in government financial regulations?

Secondly, national bonds are the BOJ's common collateral and source of operations, and on top of that, from the little progress being made through loans to businesses, there is the aspect of the amount of national bonds held by commercial banks rising to a massive scale and the rising risk of floating interest rates held by commercial banks that accompany that. Actually, according to the BOJ's Financial Systems Report (April 2012), a rise in just 1% of interest on bonds, including national bonds, is the reason behind, as of December 2011, a loss of 3.4 trillion yen for major banks and 3 trillion yen for regional banks. Furthermore, these are figures excluding those for Yucho Bank. Then what would happen if there was a rise of 2%, or 3%...Just the thought of it is terrifying. Other than a recurrence of the global financial crisis, nothing is out of the question. That being so, the BOJ must concentrate all its efforts into one of the current policy targets that rivals price stability, the aim of stability in financial systems.

Masayoshi Tatebe
Professor of Finance, Banking and Monetary Policy, Faculty of Commerce, Chuo University
Born in Osaka Prefecture in 1944. Completed his master's degree at the Graduate School of Economics, Osaka City University in March 1968. Assistant at the Faculty of Commerce, Chuo University from April 1968. Started current position after working as a full time faculty and assistant professor. Doctor of Commercial Science. Major publications include, Kanri Tsuka Seido to Gendai [Controlled Currency System and Modern Times] (Shinhyoron, 1980), Kahei/Kinyuron no Gendaitekikadai [Contemporary Task of the Money and Financial Theory] (Otsuki Shoten, 1997), and Kinyukikika no Nichigin no Kinyuseisaku [Bank of Japan's Monetary Policy in the Face of the Banking Crisis] (Chuo University Press, 2010). His current research topics are the range of endogenous monetary supply, effects and limits of the BOJ's easy money policy, and composition of the world economic crisis, global financial crisis and its outcome.