As I write this post, I am looking out at a Tokyo skyline the day after the most radical ever experiment in Japanese monetary policy was announced. The new central bank governor, Haruhiko Kuroda, has promised to double the monetary base over the course of two years and buy government bonds. And if that doesn’t do the trick of reigniting inflation, then he will buy some more.
In and of itself, doubling the monetary basis is meaningless in terms of GDP unless it translates into an expansion of credit. That is credit to households (allowing greater consumption), to corporations (allowing greater investment) or to government (allowing greater public spending),.
The assumption behind all of this is that Japan’s current rate of economic growth—basically close to zero—is ‘unnatural’. In other words, despite Japan’s ageing demographics, stagnating productivity gains and negative exposure to the long-term upward trend in commodity prices, Kuroda believes that Japan still deserves to grow at 2% per annum or so.
In your dreams.
To be effective, Kuroda’s approach requires a transition mechanism between the monetary economy and the real economy. Given he is buying assets, that transition mechanism rests with the asset markets. But what he ultimately wants to influence is a flow, that is GDP, not a stock, that is asset prices. Putting the government to one side, Kuroda’s game is to crowd out individuals, banks and corporations from the Japanese government bond market. His clearly stated goal is to ignite 2% inflation, but his specific policy tool is to keep interest rates close to zero all along the yield curve to as far out as 40 years. So he is saying loud and clear: “Bugger off out of government bonds or else I’ll inflate you away!”
“Be careful what you wish for,” I mutter to myself.
For a start, he must be careful that they “bugger off” in an orderly fashion. If everyone “buggers off” en masse all at once—and the Japanese do love a craze— Kuroda ends up owning the Japanese bond market. Last week, the Bank of Japan published its latest ‘flow of funds’ comparing Japan with the U.S. and Euroland (click the chart for larger image). As you can see, households, particularly the elderly ones, are clustered in bank deposits. The banks, in turn, invest in Japanese government bonds. So basically the majority of household savings are invested in the equivalent of a Japanese mutual fund for bonds—just at one step removed.
So, to repeat, Kuroda wants them to “bugger off” out of their indirect Japanese bond mutual fund holdings and do something more constructive with their money instead. Paraphrasing Monty Python’s “Life of Brian”, the question then is “How shall we bugger off, O Lord?” Continue reading