The Bank of Japan Renews Its Commitment to Do Whatever It Takes

Link to Wikipedia article on Haruhiko Kuroda

I am not impressed by a target of zero for 10-year Japanese government bonds as stimulative measure, when they have been trading at negative rates. Fortunately, I think this is simply a sign that the Bank of Japan is continuing to search for new tools. And, as you can see from “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide,” there are tools available that are much more powerful than anything the Bank of Japan has used so far. 

In particular, one of the most powerful tools the Bank of Japan has not yet tried is a negative paper currency interest rate through a gradually increasing discount on paper currency obtained from the cash window of the Bank of Japan (and a corresponding gradually increasing discount in what is credited to a bank’s reserve account when paper currency is deposited). A negative paper currency interest rate in turn makes it possible to cut other short-term interest rates much further.

Watching the Bank of Japan’s actions over the last few years and talking to its chief, Governor Haruhiko Kuroda, at Jackson Hole, left me confident about the Bank of Japan’s willingness to try new tools. What I wondered is whether the Bank of Japan would declare that it was already close to the natural rate of unemployment, and so didn’t need to do much more. My view is that after 20 years of slump, the Bank of Japan needed to risk overshooting its inflation target in order to find out both what its natural level of output really is, and to find out what it takes to permanently raise inflation to 2%, as it has decided it wants to do. In its September 21, 2016 statement, the Bank of Japan declares that it has come around to that point of view–better to risk overshooting than to undershoot:

The Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds the price stability target of 2 percent and stays above the target in a stable manner. Meanwhile, the pace of increase in the monetary base may fluctuate in the short run under market operations which aim at controlling the yield curve. With the Bank maintaining this stance, the ratio of the monetary base to nominal GDP in Japan is expected to exceed 100 percent (about 500 trillion yen) in slightly over one year (at present, about 80 percent in Japan compared with about 20 percent in the United States and the euro area). 

The Bank will make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target of 2 percent.

I think it is this stated willingness to overshoot, not the introduction of an explicit yield-curve targeting, is what caused the yen to depreciate on the Bank of Japan’s September 21 announcement. 

The other key section of the the September 21, 2016 statement is the section labelled “Possible options for additional easing”: 

With regard to possible options for additional easing, the Bank can cut the short-term policy interest rate and the target level of a long-term interest rate, which are two key benchmark rates for yield curve control. It is also possible for the Bank to expand asset 5 purchases as has been the case since the introduction of QQE. Moreover, if the situation warrants it, an acceleration of expansion of the monetary base may also be an option.  

Note the specific mention of lower short-term rates as an option. 

Beyond the policy of a gradually increasing discount on paper currency obtained from the cash window of the Bank of Japan to make it possible to lower short-term rates without inducing massive paper currency storage, the most important complementary policy is one to make negative rates more acceptable politically: a shift in the details of the interest on reserves formula to explicitly link the amount of funds on which banks can earn an above-market interest rate to their provision of zero rates to small household accounts. The government retail bank represented by Postal Savings should also be part of this program, just as if it were a private bank (although its subsidy could come from another arm of the government rather than from the interest-on-reserves formula). Here is how it works, as I detailed in my post “Ben Bernanke: Negative Interest Rates are Better than a Higher Inflation Target”: 

I have advocated arranging part of the multi-tier interest on reserves formula to kill two birds with one stone: not only support bank profits but also subsidize zero interest rates in small household accounts at the same time–the provision of which is an important part of the drag on bank profits as it is now. I think being able to tell the public that no one with a modest household account would face negative rates in their checking or saving account would help nip in the bud some of the political cost to central banks.

To avoid misunderstanding, it is worth spelling out a little more this idea of using a tiered interest on reserves formula to subsidize provision of zero interest in small household checking and savings accounts. To make it manageable, I would make the reporting by banks entirely voluntary. The banks need to get their customers to sign a form (maybe online) designating that bank as their primary bank and giving an ID number (like a social security number) to avoid double-dipping. In addition to shielding most people from negative rates in their checking and savings accounts, this policy also has the advantage of setting down a marker so that it is easier for banks to explain, say, that amounts above $1500 average monthly balance in an individual checking+saving accounts or a $3000 average monthly balance in joint couple checking+saving accounts would be subject to negative interest rates. That is, the policy is designed to avoid pass-through of negative rates to small household accounts but encourage pass-through to large household accounts, in a way that reduces the strain on bank profits.

Finally, in Japan, I would tie the ability of banks to get an above-market rate on a portion of their reserves to their passing along the discount on paper currency to their customers when their customers withdraw paper currency, so that regular people would get the benefit of that discount, too.

With the combination of a negative paper currency interest rate induced by a gradually increasing discount on paper currency obtained from the cash window of the central bank, and effective subsidies to support zero rates on small household accounts to make negative rates in general more acceptable, the Bank of Japan would have as much firepower it needs to achieve its goals. 

Given how little we understand about economies that have been in a 20-year slump, I applaud the objective the Bank of Japan has now announced of continuing to stimulate the Japanese economy until the signs of the Japanese economy being above the natural level of output become absolutely unmistakable by inflation going above 2%. In the case of Japan, the economic risk from doing too little is much greater than the risk from doing too much. 

Note: I will be going to the Bank of Japan to deliver this message personally in a few days. I have seminars scheduled at the Bank of Japan on September 27 and October 7. You can see the regularly updated itinerary for all of my travels to promote the inclusion of full-bore negative interest rate policies in the monetary policy toolkit in my post Electronic Money: The Powerpoint File