Thursday, April 4, 2013

Japan overhauls monetary policy, economy picking up

    Japan's central bank launched a radical overhaul of its monetary policy framework in an ambitious effort to banish deflation over the next two years through massive purchases of government bonds and a doubling the country's monetary base.
    At the first board meeting under its new governor, Haruhiko Kuroda, the Bank of Japan (BOJ)  replaced it's current asset purchase program with "quantitative and qualitative monetary easing," under which it will no longer target the overnight call rate, which has been at effectively zero since December 2008, but the monetary base, or the amount of money in the economy.
    The BOJ was also considerably more optimistic about Japan's economy, saying it had now "stopped weakening and has shown some signs of picking up." Last month, the BOJ only observed that the economy had stopped weakening, and has now added the sentence that it sees signs of a pickup.
    It also said that Japan's economy should return to a moderate growth path on the back of firm domestic demand and stronger growth overseas.
   Although Japan continues to battle with falling consumer priced, the BOJ said "some indicators suggest a rise in inflation expectations," the first sign that consumers and investors may be reacting to Prime Minister Shinzo Abe's efforts to get the economy going and rid the country of deflation.
    Japan has been caught in a cycle of declining prices for almost two decades and in February the inflation rate was a negative 0.7 percent, the ninth month in a row of deflation.
    Under pressure from the newly-elected Abe, the BOJ in January adopted an inflation target of 2 percent, hoping that this would change consumers and businesses' expectations and boost prices.
    At that point the BOJ only said it expected to achieve this target at the "earliest possible time" and has now added that this target should be reached in the next two years, one of Kuroda's stated aims.
    Although Kuroda has only been BOJ governor for two weeks, the nine-member BOJ board was unanimous in approving the new aggressive policy with the only disagreement revolving around the phrasing of the two-year target.
    The BOJ said it expects its new quantitative and qualitative easing program to keep interest rates low and "also to drastically change the expectations of markets and economic entities," and "contribute to a further pick-up in inflation expectations that appear to have risen, and lead Japan's economy to overcome deflation that has lasted for nearly 15 years."
    Under the new program, the BOJ aims to boost the monetary base by 60-70 trillion yen annually to a total of 200 trillion yen by the end this year and 270 trillion end-2014 from 138 trillion at the end of 2012 through money market operations. This compares with the U.S. monetary base of $2.84 trillion, or some 268 trillion yen, at the end of February.
     In order to push down interest rates across all maturities, the BOJ will buy government bonds at an annual pace of about 50 trillion yen, or about 7 trillion a month. The BOJ will no longer focus its purchases on shorter maturities but include 40-year bonds so the average remaining maturity of its new bond purchases will extend to about seven years from less than three years.
    The BOJ will also boost its annual purchases of Exchange Traded Funds (ETFs) and real estate investment trusts, so-called J-REITs, by an annual 1.0 trillion and 30 billion yen, respectively.
    "The Bank will continue with the quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining the target in a stable manner," the BOJ said, adding it would adjust its policy in light of upside and downside risks.
    The BOJ is one of the pioneers in using its balance sheet to stimulate economic activity and its current asset purchase program, which was launched in 2010 and aimed at purchases of 101 trillion yen by 2014, would be absorbed into the new program.
     The BOJ's decision to scrap its target for the overnight interest target shows how far central banking has come since the 2008 financial crises. At that point, many major central banks cut rates to effectively zero and were forced to use their balance sheets to boost demand.
    The BOJ initially cut its overnight rate to 0.1 percent in 2008 and then trimmed it to the current level of 0-0.1 percent in 2010.
    The BOJ temporarily suspended its so-called banknote principle, saying the new bond purchases are for the "purpose of conducting monetary policy and not for the purpose of financing fiscal deficits," addressing the fear that the BOJ may be loosing some of its independence and will now just be used to finance government deficits.
    Under the banknote principle from March 2001, the BOJ had to limit its bond purchases so the total outstanding amount of long-term government bonds was below the stock of banknotes.
    Japan's Gross Domestic Product stagnated in the fourth quarter from the third, following contractions in both the third and second quarters, for annual growth of only 0.5 percent, marginally above the third quarter's 0.4 percent growth rate.


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