Originally published in Japanese on May. 15, 2023
Quarter-century of “untraditional” policy
At his inaugural press conference on April 10, Ueda had already expressed his thinking on the issue, saying there should be a deeper understanding of the untraditional monetary policies that have been in place for many years to overcome deflation, and that these policies should be examined and verified to serve as references for future monetary policy. The decision at the late April meeting was therefore not a surprise.
With observers focused on an exit from the 10 years of unconventional monetary easing under former Governor Haruhiko Kuroda, the decision to review the past 25 years of policy may have come as a surprise. However, Ueda’s understanding of this issue is important.
Since the late 1990s, when prices began to fall, many have called for an end to deflation. With no room for interest rates to fall, “untraditional” policies were put in place: zero interest rates, forward guidance, and quantitative easing. The quantitative and qualitative monetary easing that began under Kuroda is an extension of this.
The joint statement produced by the government and the BOJ (the Accord) added extra “unconventional” elements to monetary policy by making it government-led, raising the price target to 2%, and rapidly accelerating the pace of BOJ purchases of long-term government bonds and other assets to achieve this target. Even after exiting from “unconventional” monetary policy, the “untraditional” policies aimed at exiting deflation will remain in place. Without a second exit from these conditions, monetary policy cannot be normalized.
However, there are significant political obstacles to achieving this second exit, as it could negate 25 years of monetary policy. It is unclear if this will happen during Ueda’s 5-year term as governor of the BOJ. The policy review likely will not begin as an inspection or verification with specific monetary policy changes in mind, but rather as a summary of the major issues from a long-term perspective.
Although, changes in monetary policy will come regardless of this review as policymakers bear in mind the side effects of unconventional monetary easing.
A shift to an Ueda-style form of policy began at his first monetary policy meeting as governor.
Strengthening forward guidance
First, he clarified that the 2% price stability target must be achieved in a manner that is accompanied by an increase in wages. Kuroda had also repeatedly stressed the importance of wage increases at his press conferences, but this time forward guidance was strengthened by noting the importance of wage hikes in the announcement released after the monetary policy meeting.
With the 2% price stability target still unrealized in a sustainable and stable manner, Ueda is continuing the monetary easing policies of Kuroda, his predecessor. However, the consumer price index has already exceeded the 2% target for more than one year, and price increases are spreading faster than the BOJ had assumed. In that context, there is a risk that depending on future price trends, medium- and long-term Japan government bond (JGB) yields could skyrocket, even if the BOJ wishes otherwise.
The yield-curve control currently in place is prone to speculation as market participants try to anticipate a change in the guidance target or a widening of the target range. To address this, the BOJ has purchased large amounts of JGBs, which has had the side effect of reducing the functioning of financial markets and expanding the BOJ's balance sheet.
By strengthening its forward guidance, the BOJ has made it clearer that it will not change its monetary easing policy simply because consumer prices have risen. This will have some effect in suppressing speculation regarding interest rate hikes.
Move to nimbler policy
Furthermore, the section on the basic stance of monetary policy in the statement released after the meeting began by stating, “The Bank will patiently continue with monetary easing while nimbly responding to developments in economic activity and prices as well as financial conditions.” Under Kuroda, it began with the phrase, “aiming to achieve the price stability target of 2%.”
Until now, the realization of the price target had been positioned as if it were the sole and absolute goal of monetary policy. Until prices rise, monetary easing has continued unabated, even as the economy continues to recover and financial markets stabilize.
From now on, instead of an extreme monetary policy, market participants can expect a return to the starting point of monetary policy, which is to achieve stability in the economy, prices and financial conditions. The aforementioned basic policy of aiming to achieve the price stability target along with rising wages can also be said to be a monetary policy that pays attention not only to prices but also to the economy.
Regarding additional monetary easing measures, before the COVID-19 pandemic, the BOJ described “a greater possibility that the momentum toward achieving the price stability target will be lost” as a condition for such a move. After the response to the pandemic began, the link to the price target was removed, and the wording said that the BOJ would closely monitor the impact of COVID-19 and take additional steps if necessary.
Since April last year, the phrase “the Bank will support financing, mainly of firms, and maintain stability in financial markets” was added just after the line noting the central bank would closely monitor COVID-19. Additionally, at this most recent meeting, the phrase “closely monitoring the impact of COVID-19” was removed.
Lending under the special operation for financial assistance in response to COVID-19 ended in March of this year, and considering that the outstanding loan balance will be zero at the end of June, these steps seem natural. It is also not appropriate to revert to the language linking the price stability target before COVID-19, even though consumer prices have risen more than the BOJ assumed. As a result, the wording of the statement put preparedness of financial conditions foremost in light of unstable market trends overseas.
Removal of rate guidance
In the most recent policy statement, the forward guidance that the BOJ “also expects short- and long-term policy interest rates to remain at their present or lower levels” was removed.
When this guidance was first introduced, it was described as a sign of the BOJ's willingness to take additional monetary easing. Reading the text on its own, however, it does not read quite that way. It reads such that the BOJ is prepared to lower the policy rate when the market prompts additional easing, such as when long- and short-term yields fall below the policy rate, but it also provides a loophole that allows the central bank to avoid additional easing if it guides the long- and short-term yields higher.
Furthermore, when the guidance was first introduced, there was a timeframe that noted that caution should be exercised over fears that momentum toward the price stability target could be undermined. This gave some plausibility to the explanation that the guidance indicated additional monetary easing. However, as the BOJ moved to respond to COVID-19, the reference to this time frame was removed, and the forward guidance became largely meaningless.
One could think that the guidance was removed because it would have been meaningless to keep it in the statement. But more than becoming meaningless, the forward guidance risked becoming an actual hindrance.
If the BOJ intends to base its monetary easing on a zero-interest-rate policy and strong forward guidance, it is assuming a fairly flat yield curve shape originating from the policy rate. If forward guidance on policy rates remains in place, it is easy to speculate about policy rate cuts. The removal of forward guidance on policy rates may be the central bank laying the groundwork for a return to a zero-interest-rate policy.
Wait and see
On the other hand, if the BOJ were to make any kind of change to its monetary policy framework, including a return to zero interest rates, it would be contingent on achieving the 2% price stability target.
The BOJ continues to judge that the 2% price stability target has not yet been achieved. As noted above, the forward guidance has also been strengthened, raising the bar for the central bank to judge that its goal has been met. Declaring the target achieved could cause yields to spike, so caution may be needed in making that decision. However, it cannot be postponed indefinitely.
Ueda also said at a press conference that the decision about whether the 2% target had been met could come before the results of next year’s spring shunto wage negotiations are known.
Fears are gradually growing that inflation will continue to increase so long as the BOJ does not declare the 2% target met. Conversely, if the rate of price increases falls below 2%, the BOJ misses the chance to finally declare the price target, which has finally come, achieved. The next opportunity will not come for some time.
While the BOJ expects the positive rate of price inflation to narrow toward the middle of this fiscal year, it also sees more upside risk than downside risk to that outlook.
If so, the BOJ may decide to change its monetary policy framework after confirming how much price increases will contract, and then indicate its judgment that the price target has been achieved in the BOJ’s October Outlook Report.
(Originally written in Japanese by Akihiko Suzuki, translated and edited by Connor Cislo)
