Japanese monetary policy could be about to get really radical

REUTERS/Thomas Peter

Global markets, particularly in Japan, are in the midst of a full-on stimulus splurge at present.

Japanese prime minister Haruhiko Kuroda just had a decisive victory in upper house elections, fought on whether “Abenomics”, as it is known, should continue, while former US Federal Reserve chair, Ben Bernanke, met with both the Bank of Japan (BOJ) and the government, fueling expectations that an enormous fiscal and monetary stimulus package is coming.

Given the precedent already set by the BOJ with its negative interest rate policy and QQE policies, that’s saying something.

Japanese stocks are soaring along with the USD/JPY.

Stimulus is on the way, say the markets. The only questions now is what form it will take, and just how large it will be. Given the moves in financial markets over the past few days, investors are betting that it will be mammoth.

According to Tom Kenny, Brian Martin and Dan Wilson, members of ANZ’s economics team, “the BOJ and government need to try something different to more forcefully and sustainably lift inflation and inflation expectations”.

In their opinion, the BOJ’s objective of trying to achieve inflation within two years lacks credibility and is causing confusion. Not only that, it simply isn’t working.

“Not only is the life span of the central bank’s QQE strategy running out, additional easing does not seem to be providing any net benefit, the trio say.

And, as ANZ points out, these asset purchases don’t come without their problems.

“The BOJ is holding close to 40% of all JGBs. Its dominance in the market is distorting liquidity in the JGB market and thus price discovery in asset markets,” say ANZ.

“The central bank’s annual purchases dwarf the government’s yearly net financing requirement, which means it has to get existing JGB holders to sell. We are getting closer to that point where the flow from sellers will not be enough.”

Indeed, the BOJ is already purchasing exchange-traded funds (ETFs) and real estate investment trusts (J-REITS) and has introduced negative interest rates yet deflation remains firmly entrenched.

Economic growth, too, continues to bump along, with a solid expansion one quarter often followed by an equally large contraction the next.

What will alternate asset purchases, or deeper interest rate cuts, actually deliver? Lots of asset price bubbles, is a common answer that’s been heard, but little to no benefit to the actual economy.

After more than three years of failure, scepticism of existing policies reigns supreme.

Just look at the size of the BOJ’s balance sheet as a percentage of GDP, compared to that of the US Federal Reserve. For all the assets that the BOJ has bought, it’s delivered very little.

REUTERS/Thomas Peter

Given the dismal track record, markets are now speculating that the Bank of Japan will go have to “nuclear” if it truly wants to spur on inflation and economic activity, enacting a policy where increased fiscal spending will be directly financed by the bank.

Helicopter money, in other words — the phrase first coined by Milton Friedman and made famous by Bernanke, invoking images of bags of cash being tossed out of choppers in order to encourage spending.

It involves direct cash payments, to the private sector, funded by a central bank and distributed by the government.

Nuclear enough for you? It’s akin to going all in, for those of you who play poker. The final resort to stave off deflation when fiscal and monetary policy easing has been exhausted.

“This seems to be the situation in which Japan finds itself now, with public debt almost 250% of GDP and the shelf life of QQE nearing an end,” says ANZ.

If the BOJ decides to go down this extraordinary path, ANZ’s trio believe policymakers must tread carefully, and perhaps more importantly, convey the message that it’ll be more than a temporary measure.

They explain:

There needs to be close collaboration between monetary and fiscal policy. The central bank’s independence should not be compromised, it should not be seen to be a printing press for the government. The government, not the central bank, should make the decision on how best to distribute the funds (tax cuts, increased wages for public servants, public works).

The public must view the increase in monetary supply as permanent. If not, then the increase would be akin to debt-financed fiscal expansion and may have little stimulative properties. This increase in the money supply would be inflationary. To achieve this, the government could issue a perpetuity bond with a zero coupon that the BoJ holds on its balance sheet. A zero coupon bond means the government would not pay interest on the debt. If the government were to pay interest, then this would negate some of the fiscal stimulus.

The Bank of Japan next meets on July 28, before announcing its monetary policy decision on the 29th.

No matter what the outcome, whether it be “nuclear” or another policy “wet lettuce leaf”, it sets the stage for another dramatic, and potentially unprecedented, Friday for financial markets, just one month after the last.

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