How Japanese policymakers fell into a very deep hole

Iinvestor’s bet About the Bank of Japan’s Tight Monetary Policy (Boji) have barely won the ultra-low interest rates of the past 30 or so years.First decision by BojiNew Governor Kazuo Ueda was no exception. The central bank’s flagship policy, yield curve control, which caps the yield on 10-year government bonds at 0.5% and aggressively buys government bonds, was not changed on 28 April. instead, Bojiof policymakers announced a review of monetary policy. The exercise is expected to last him a year, possibly longer.

Watching a speculator re-nursing a burnt finger is a dark comedy. But policy review may prove more meaningful than a seemingly bureaucratic task. The report Boji Since the Japanese economy entered deflation in the 1990s,

The starting point must be the harsh realities facing central banks. Yield Curve Control, launched in 2016, Boji‘s massive asset purchases were causing problems with the functioning of the country’s bond markets.of BojiInflation in Japan is at its highest level since the early 1980s, but even a modest rise in interest rates could be devastating to the economy. After decades of attempts to stimulate a stagnant economy, the country’s central bank is in nasty bondage, unable to move much in any direction.

To understand why, it helps to go back to the source of the problem. In the late 1980s, Japan experienced a huge asset bubble, mainly in stock prices and real estate prices. Six of the ten most valuable companies in the world call this country their home. Rising interest rates in 1989 deliberately burst the bubble, and stock prices immediately fell, with land prices falling further throughout his 1990s. Since then, Japan has been trapped in what Nomura Research Institute’s Richard Koo, who is associated with the bank of the same name, called a “balance sheet recession.” Businesses and households are concentrating on debt repayment rather than investment and consumption, hindering economic growth.

After decades of thrift, Japanese residents have far more financial assets than debt and appear less vulnerable to rising interest rates. Instead, prefer bank deposits. Bank deposits now hold a staggering ¥1.1 trillion ($8 trillion), equivalent to almost 200% of Japan’s deposits. gdpNon-financial companies hold an additional ¥561 trillion.

All over the world, household budgets are usually squeezed by higher prices. Japan could be a beneficiary, at least in the short term. Marcel Tyriant of research firm Capital Economics points out that for every 1 percentage point rise in Japanese interest rates, household net interest income rises by 4.7 trillion yen, or 1.5% of annual disposable income. Coupled with a stronger currency, making imports into the country cheaper, households seem more likely to enjoy higher interest rates.

However, the pain is felt elsewhere. The first to suffer are the institutions that have become far more indebted because the private sector has saved: the central government. Last year’s budget allocated about 8% of spending to interest payments, even though the average interest rate on government bonds is he 0.8%. As bonds roll over, an across-the-board interest rate hike would mean more than doubling the share of spending.

The impact will trickle down over the years, though not as slowly as it once did.the fact that Boji It now owns more than half of Japan’s bond market, and many of the longer-maturity bonds are increasing the pace at which rising interest rates impact financial calculations.When Boji When you buy a bond, you create a reserve asset to pay the base interest rate. If interest rates rise Boji Soon we will owe more to these reserves. It will bear the losses that the government has to pay.

The second part of the economy that will soon feel the pain of rising interest rates is the banking system. Higher interest rates can cause large unrealized losses on the assets of smaller financial institutions. The Japan Center for Economic Research, a consultancy, suggests that if long-term interest rates rise by 1 percentage point, the economic value of regional banks (the value based on expected cash flows from their assets and liabilities) will decline by 10%. equivalent to 60% of their capital.

i don’t start here

Dramatically undermining some of Japan’s most vulnerable financial institutions to squash demand is, if not the ideal way to achieve such a goal, the ultimate result of recent inflation. It would work as a way to limit the surge. Fiscal stimulus is on track, even as government debt has increased significantly over the past three decades. Enough to prevent an entire economy from collapsing, but not enough to ignite stronger growth. For years, a concerted effort to increase consumer spending through more aggressive government spending has been a clear Keynesian prescription for Japan. Rising government bond yields complicate the situation.

It sounds a little strange to say that Japan is still recovering from a crisis that began around the same time as the fall of the Berlin Wall, but the country’s economy has never experienced a coordinated recovery from the bursting of an asset bubble. . In 1990, Japan’s gdp Per capita was about 18% lower than US levels. According to the same measure in 2021, her per capita economic output in Japan was 39% lower than in the United States.

As such, the world’s third-largest economy is still in trouble, and its policymakers are helping to keep it going.Mr. Ueda, an outsider Boji From academia, we have the opportunity to tell it openly. A review should be a cry for help. Acknowledging the problem is the first step in finding a solution. Especially if the solution is uncomfortable. ■

Read more about our column on economics, Free exchange.
Economists and investors should pay less attention to consumers (April 27)
Is China better at monetary policy than the US? (April 20)
How the State Can Control the Banking System (April 12)

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