The Bank of Japan is now considering whether to move to balance sheet expansion in its bid to lift the Japanese economy out of deflation. Japanese policy, which will then further tighten the nexus between fiscal and monetary policy, is now the furthest along the path toward the consolidated fiscal and monetary approach that is occurring nearly everywhere in the crisis currency zones.
According to Reuters, the latest considerations are something that Japanese central bankers are discussing ahead of the shift in leadership that sees Haruhiko Juroda take over the helm.
“The BOJ’s current policy is still about controlling interest rates. Shifting that focus to balance sheet expansion will open up a lot of possibilities in terms of policy options,” said one of the sources.
The difference between the two approaches is a subtle one in that the central bank’s current policy tool – a 101 trillion yen $1 trillion (664.58 billion pounds) programme of asset buying and lending – also expands the BOJ’s balance sheet, which at a third of GDP is a bigger proportion of the economy compared with those of the U.S. and European Union’s central banks.
But proponents suggest measuring the central bank’s actions by the expansion of the balance sheet has a better chance of finally shaking Japanese out the psychology of deflation that has become entrenched during the past two decades.
It will be easier to convince the public of the central bank’s efforts to reinflate the world’s third-biggest economy if they can easily measure jumps in the size of the BOJ’s balance sheet, supporters of the idea say.
On the other hand, trying to push down interest rates that are already low has limited potential, they say.
We can look at this as a hallmark of Abenomics as the economic policy of Japan’s Prime Minister is called. The approach is to go guns blazing on both the fiscal and monetary side in support of increased economic activity, rather than letting monetary policy do the heavy lifting alone. A lot of commentators have pointed to the new Japanese economic policy as a renewed salvo in the long-running currency wars. To wit, the Japanese yen has depreciated in value along with this policy’s denouement. However, the goal is to reflate the domestic economy by any means possible with the currency depreciation as an integral part of that goal.
The effectiveness of monetary policy alone has been poor during this economic crisis. And so, governments are increasingly looking at other ways to reflate their economies. The approach we are seeing most is what I have labelled the consolidated balance sheet approach because it represents the end of full central bank independence as the government’s agent in setting monetary policy on the government’s behalf and the beginning of central bank working in concert with fiscal policy. Japan is furthest along in this policy paradigm shift because it is furthest along into debt deflation. However, I believe this is where all of the crisis currency zones are now headed.
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My expectation is that, as this crisis drags on, policy makers will come to understand that monetary policy is tapped out, that the new monetary policy tools are only effective in concert with expansionary fiscal policy. The United States was the last holdout on austerity and is now succumbing as well. I expect this to mark the peak of the global economic cycle, with another global economic downturn making plain how ineffective the monetary tools are. And then the consolidated balance sheet approach will ratchet up everywhere as countries desperately look for ways out of the economic malaise. Japan is the first on that path.