Has the Bank of Japan Exhausted Monetary Easing Options?


Following the global financial crisis in 2008, Japan has had it rough. Gross domestic product (GDP) growth rates have remained at around 1%, per-capita income has stagnated, the debt to GDP ratio stands at the highest of all OECD countries at 229%, and foreign direct investment remains critically low.

To combat the dire state of affairs in the world’s third largest economy, Prime Minister Shinzo Abe has implemented a “three arrow” economic strategy known as Abenomics. This strategy is founded on monetary easing through central bank policy, significant government spending in the form of fiscal stimulus and deregulation for business to encourage investment.

Abenomics has resulted in varying degrees of success.

Since 2012 the value of the Yen has declined by about 30% due to an aggressive quantitative easing campaign by the BoJ, rendering Japanese exports more competitive and increasing profits earned in foreign currency. Business deregulation has led to an increase in investor confidence and the 116 billion USD stimulus has been relatively successful in boosting inflation.

Notwithstanding, Japan has consistently missed its target of 2% inflation, GDP contracted by an annualised 1.1% in the last quarter of 2015 and is expected to fluctuate around zero in the first half of 2016, and investment remains low.

In January of this year the BoJ took its aggressive monetary easing a step further and introduced negative interest rates, essentially charging banks for depositing reserves at the BoJ. This was a move alleged to encourage “banks to lend, businesses to invest and savers to spend” in an attempt to counterbalance the effects of China’s economic slowdown and declining global energy prices.

On April 27th, investors expected the BoJ to follow up January’s negative rates with a further decrease. However, the markets were shocked when the BoJ decided on inaction and left interest rates unchanged. As a result the Yen surged 3.2% against the dollar and the Nikkei 225 dropped by 3.6%.

The inaction taken by the BoJ has led to speculation regarding the banks ability to further stimulate the economy and reach its targeted 2% inflation. With interest rates already in negative territory, what ammunition does the BoJ have left?

Haruhiko Kuroda, governor of the BoJ, has assured the public that “there is plenty, plenty of room to push down the negative rate” and there is no change in the banks approach to do whatever is necessary to achieve inflation goals.

Many analysts, such as economist Mohammad El-Erian, do not share the BoJ’s optimism. El-Erian was reported telling CNBC, “the shocker is whatever [the BoJ does], they get it wrong. They ended up doing too much [by lowering interest rates in January], and they suffered a currency appreciation, and they did nothing this time, and they got the same outcome.”

Conversely, Stefan Worrall, director of Japan equity sales at Credit Suisse in Tokyo, has contended that Japan has taken the only sensible course of action given the US Federal Reserve’s recent decision to leave US interest rates unchanged. BoJ inaction is recognition that the Yen’s value is largely contingent upon FED policy and investor’s interpretations of said policy.

Regardless of where one’s sympathies lie, it is evident that Japan is consistently missing its economic targets and perhaps it is time to reassess current strategies.

Central bank policy has been vital in stimulating economic recovery subsequent to 2008, but given Japan’s current economic woes and missed targets, it is likely that Abe will turn towards fiscal policy to supplement the BoJ’s monetary easing. For example, it is expected that Abe will postpone a rise in consumption tax, which is currently scheduled for April 2017, to encourage spending and increase aggregate demand.

Therefore, while the BoJ may still have ammunition for further monetary easing, it has become increasingly important for Abe to employ effective and appropriate fiscal policy to assist in remedying Japan’s economic woes.

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