Since the financial crisis, developed economies have turned to central banks as their only hope for stimulating demand. Trillions have been spent buying government bonds, interest rates have been kept at record lows and credit remains cheap. And still, growth in GDP, prices and wages is elusive.
When the Bank of Japan (BoJ) meets on Thursday to decide its next monetary policy move, further easing is expected. But has this reliance on monetary policy reached the end of the road?
A perennial problem
The BoJ may decide to cut interest rates further into negative territory, and expand the unconventional asset purchase programme, known as QQE, under which it buys private sector assets and not just sovereign bonds. The BoJ’s balance sheet is already massive, with assets worth around 77 per cent of GDP. Despite this, inflation remains below the government’s 2 per cent target.
Deflation is a problem which has plagued Japan for decades, thanks in part to an ageing population and low rates of birth and immigration – issues which Prime Minister Shinzo Abe’s structural reforms have failed to counteract.
Worse still, the introduction of negative interest rates in January has failed to devalue the currency in the way the BoJ had hoped. The yen is up more than 10 per cent against the dollar since January because of factors outside its control – including the US Federal Reserve’s approach to its own interest rate.
Analysts expect that any decision made by the BoJ this week will be influenced by whatever is decided when the Fed meets the day before. It is easy to see why. Since the Fed revised expectations about the number of times it will raise its benchmark interest rate this year, the greenback’s value has fallen and the yen has rocketed more than any other rich economy’s currency, damaging the competitiveness of Japanese exports.
Until now, the current stimulus plan’s forces of delivery have been a currency decline and the impact on Japan’s stock market, the Nikkei. “Both of those have run their course,” says Bill O’Neill, head of the UK investment office at UBS Wealth Management. “A stimulus plan will have to look at something other than an explicit focus on the economy delivered through an exchange rate adjustment.”
But the BoJ’s asset purchase programme is soaking up the budget deficit. By 2017, it is expected to own half of the country’s sovereign debt. Japan is reaching the point where monetary policy sustains its solvency, instead of just stabilising real government debt.
Olivier Blanchard, now at the Peterson Institute for International Economics, has said that the time may come when Japan’s government expects the BoJ to finance its debt directly, and this could lead to very high rates of inflation.
Jason Hollands, managing director at Tilney Bestinvest, says that the move to negative interest rates signals that the BoJ is “prepared to consider further unconventional policy options”. So what form could these radical options take?
Touted as a way to help Japan out of deflation back in the early 2000s, “helicopter money” is getting more and more air-time. It involves printing money and putting it directly in citizens’ pockets to encourage spending. Unlike QE, it would be irreversible, in the sense that there would be no pretence that the injection of new money would be unwound at any future point.
Helicopter money is a possibility for Japan, thinks Hollands. “But there is no certainty such a radical and untested policy would work in a country which has a reputation for individuals hoarding cash.”
Critics have highlighted a number of potential problems with this ultra-unorthodox method of stimulating the economy. First, it could lead to a loss of faith in the currency itself, raising fears of Weimar-style hyperinflation. Second, there is a real risk that the government could come to rely on money drops from the central bank, thereby eliminating all pressure to enact structural reforms that could put the economy on a more sustainable long-term footing.
The other two arrows
And in the case of Japan, given disappointment at the reforms enacted by Abe’s government so far, this could prove particularly pertinent. While the BoJ has kept to its side of the bargain with its ambitious monetary policy programmes, Abenomics’ other two arrows – fiscal consolidation and structural reform – have proven more of a disappointment and many are sceptical that Abe will deliver on them any time soon.
“Options for tax reductions and supply side reforms are limited when so many nations are still grappling to reduce their deficits,” says Hollands.
And even if some changes are actually pushed through, they may themselves cause problems, at least in the short term. Having already delayed a planned increase in the rate of consumption tax once, for example, Abe has recently said that a rise of 2 per cent will be introduced from April 2017, bringing the sales tax to 10 per cent. The last time this was raised – from 5 to 8 per cent in 2014 – shoppers splurged ahead of its introduction in March, but stopped spending once it came into effect, driving the economy into recession.
A worrying cocktail
All this adds up to a worrying cocktail for Japan. And as Capital Economics pointed out in a recent note, economic conditions do not look promising. Industrial production plunged 5.2 per cent month on month in February, there is a risk that the economy will have contracted yet again in the last quarter, inflation has moderated, and the rise of the yen could see goods inflation slow further in the coming months.
Japan has been grappling with economic stagnation for decades. Despite the efforts of its central bank, there is no end in sight.