Meet the New BOJ, Same as the Old BOJ

Despite the title of this post, I support their recent move, and think it will help.  Unfortunately it won’t help very much.  Here’s the story:

TOKYO (AP) — Japan’s central bank cut its key interest rate to virtually zero in a surprise move Tuesday and is looking to set up a $60 billion fund to buy government bonds and other assets as it tries to inject life into a faltering economy.

The Bank of Japan’s nine-member policy board voted unanimously to set its overnight call rate target to a range of zero to 0.1 percent, returning to zero rates for the first time in more than four years.

The decision underscores growing worries about the Japanese economy, which is being battered by a strong yen and persistently falling prices. The central bank had left rates untouched since December 2008 when it lowered the target to 0.1 percent.

Recent economic indicators point toward deteriorating exports, industrial production and corporate sentiment. Authorities intervened in currency markets last month to weaken the yen, but the impact was short-lived. Lawmakers repeatedly called on the Bank of Japan for more help.

.   .   .

The rate cut is the first step of a three-pronged approach outlined by the central bank to answer critics who had disparaged previous efforts as inadequate. It did nothing at its last meeting in early September, which followed an emergency meeting in late August when it expanded a low-interest credit program.

“It’s a good move,” said Kyohei Morita, chief economist at Barclays Capital Japan. “All that they announced today is something that is beyond my expectations.”

Other analysts agreed. Junko Nishioka, chief economist at RBS Securities Japan, said the central bank “made major progress” Tuesday.

Part two of what the BOJ describes as a “comprehensive monetary easing policy” is a pledge to maintain the zero rate policy until prices start rising again. That will probably take three or four years, which means rock-bottom rates are here to stay for a while, Morita said.

Japan last period of zero rates lasted for five years starting March 2001. Through its “quantitative easing” policy to boost the economy, the central bank flooded markets with excess liquidity to hold short-term interest rates near zero.

The final piece of the central bank’s strategy is the creation of a temporary 5-trillion-yen ($60 billion) fund to purchase financial assets such as government securities, commercial paper and corporate bonds in an attempt to stimulate the economy by lowering longer-term interest rates and risk premiums. About 70 percent of the fund will be used to buy long-term government bonds and treasury discount bills.

The central bank will offer another 30 trillion yen ($359 billion) through its loan program.

The rate cut gave an immediate boost to the stock market, with the Nikkei 225 index jumping 1.5 percent to 9,518.76 after spending much of the day in the red.

In the late 1990s Japanese prices were falling at an unacceptable rate.  The BOJ cut rates close to zero, and did a bit of QE.  By 2000 the deflation ended, and the BOJ tightened monetary policy.  This succeeded in preventing any significant inflation from occurring.  Soon after policy was tightened, Japan fell back into deflation.  By 2002 the rate of deflation was unacceptable, and the BOJ again cut rates to zero, and did an even larger QE.  Of course large monetary injections would be highly inflationary, unless the central bank indicates they are temporary.  The BOJ did this by promising not to allow inflation.  When inflation threatened to occur in 2006, the BOJ again tightened monetary policy, raising rates and sharply reducing the monetary base (by roughly 20%.)  This again tipped Japan back into mild deflation.  Because the rate of deflation is once again unacceptably high, the BOJ just announced a series of steps including rate cuts and QE.  As they said, deflation will last another “three or four years”.  When deflation stops, they’ve promised to tighten monetary policy again, and thus create a new bout of deflation.

Why didn’t they do this 2 years ago?  Good question, I argued they were making a big mistake in late 2008.  But given the Fed and the ECB made exactly the same mistake, I guess we shouldn’t be too hard on the Japanese.  Of course the Fed is also now contemplating actions that they clearly should have taken back in October 2008—when they instead called for fiscal stimulus.

The BOJ doesn’t seem to have changed its underlying monetary regime.  For nearly 2 decades the policy has been consistent; use rate cuts and QE when deflation is more rapid than they’d like, and raise rates and reverse QE when inflation rises to around zero percent.   The policy announcement this morning is completely consistent with this regime.  I hope I am wrong, but I don’t see any evidence the BOJ has learned from their mistakes.

Still, it is better than nothing.  The Nikkei rose 1.5% on the news, which suggests that it was a bit more than expected, albeit nothing that will significantly change the underlying dynamics.  The BOJ should aim for 3% NGDP growth, instead of the near-zero NGDP growth that has occurred since 1993.

It was 2 years ago this week that the Fed instituted its admittedly contractionary “interest on reserves” program.  The stock market suffered one of its biggest 10 day losses in recent history.   Two years later they are finally getting ready to adopt some stimulus.  Here’s some questions for my fellow macroeconomists, who offered virtually no criticism of the Fed’s contractionary policy of late 2008:

1. Given the problem of long and variable policy lags, does it make sense to wait until November 2010 to initiate a (probably timid) easy money policy to address a recession that began in December 2007?
2. Why weren’t our prominent macroeconomists demanding a much more expansionary Fed policy in October 2008?
3. Why were there almost no complaints when the Fed let yields on 5 year TIPS soar from 0.5% in July 2008, to 4.2% in November 2008?
4. Why were there almost no complaints from our elite macroeconomists when the Fed made no attempt to stop the dollar’s strong appreciation (against the euro) in late 2008?
5. The Fed called for fiscal stimulus in 2008.  Why weren’t economists asking the Fed:  “If things are so bad we need fiscal stimulus (something not even in the new Keynesian playbook) then why aren’t you making monetary policy more expansionary?”
6. In 2009 Janet Yellen suggested there was nothing more the Fed could do because rates were at zero.  Why didn’t those economists who are now pressuring the Fed for easier money, criticize Yellen’s statement in 2009?  Why aren’t they saying she’s unqualified to serve on the Federal Reserve Board?
7. Why do our nation’s prominent macroeconomists keep saying Japan is “stuck” in a liquidity trap, when the BOJ’s words and actions suggest otherwise.