At its policy meeting on 29 July, the Bank of Japan (BoJ) disappointed many market analysts (especially those outside of Japan) by not doing much of anything except some additional buying of exchange-traded funds (ETFs) to support stocks. This move might marginally help stocks, but will not help economic growth or stoke inflation. So, the immediate market response was a strengthening of the yen vs. the U.S. dollar, which was probably not what the central bank was hoping would happen.
We would urge some caution in interpreting the BoJ’s inaction.
The central bank was very clear that it retains a commitment to getting the inflation rate back up to 2%.
And, it also made clear that it was in the process of a thorough review of monetary policy.
This is very good news. From the U.S. Federal Reserve to the European Central Bank (ECB) to the BoJ, massive asset purchases known as quantitative easing (QE) coupled with near zero to slightly negative interest rate policies over the six years since the economic expansion restarted in 2010 have produced no inflation pressure and no additional economic growth. That is, these unconventional monetary policies can lower government bond yields to zero or even into negative territory, but they have not helped to achieve economic growth and inflation policy objectives.
Indeed, we have argued (see article in Yahoo Finance) that the distortions in the credit markets from unconventional monetary policy actually have contributed to this post-recession economic cycle being more anemic than usual compared to what would have been expected. To grow, economies need well-functioning credit markets, and pushing interest rates too low creates an unhealthy search for yield by pension funds. And, retirees do not get the income they expect from their portfolios, so they consume even less. QE destroys bond market liquidity and damages prospects for credit growth. Negative rates diminish bank profitability and constrain banks’ ability to lend in support of any economic expansion.
Unconventional monetary policy is a triple-whammy of economic distortions that hinder economic growth. Reviewing and reconsidering failed policies is absolutely appropriate.
Moreover, Japanese Prime Minister Shinzo Abe has promised to deliver considerable additional fiscal stimulus. We are missing the details of the new fiscal plan, and if the past is any guide, the public relations may be much more aggressive than the actual stimulus. Things like money to be to committed to loan guarantees rarely work as stimulus; they are just subsidies to the sector getting the guarantees. The fiscal stimulus that works to promote more economic activity is actual new spending that gets money into the economy quickly. And, Abe was not clear on how much of the new fiscal program would involve actual new spending that would hit the economy in 2016 or early 2017.
Finally, we note that if the BoJ commits to buying the government bonds that would fund the new fiscal spending, then this would create a pairing of monetary and fiscal policy that might work. QE to support brand new government spending does not destroy the liquidity of the existing outstanding debt in credit markets, and it does lead to immediate spending in the economy. Stay tuned, as the devil is in the details of the new fiscal policy, as to how it will be supported by monetary policy.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Bluford “Blu” Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. With more than 35 years of experience in the financial services industry and concentrations in central banking, investment research, and portfolio management, Blu serves as CME Group’s spokesperson on global economic conditions.
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