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How can the Bank of Japan contain side effects while maintaining monetary easing? It can be said that the central bank had to make tough choices in its policy review.
The BOJ decided to revise its monetary easing policy at its Monetary Policy Meeting.
The pillars of the review include taking a flexible approach to the guidance target for the 10-year Japanese government bond yield, which has been keeping interest rates low, and reviewing the purchase policy for exchange-traded funds (ETFs), which the central bank has been purchasing as part of its easing policy.
Monetary policy is playing an important role in overcoming deflation, but the negative effects of prolonged easing are becoming more noticeable. It is commendable that the central bank has decided to modify the policy.
The central bank began its ultra-loose monetary easing in 2013, purchasing large amounts of government bonds and other securities. In 2016, it introduced a negative interest rate policy and a guidance target for the long-term bond yield in its continued strengthening of easing policies.
However, there is still no prospect for when the BOJ’s target of 2% inflation will likely be realized. The situation has become more severe due to the novel coronavirus pandemic.
Meanwhile, the prolonged ultralow interest rates have put pressure on the earnings of financial institutions. Problems such as sluggish trading in the government bond market have also arisen. It is necessary to devise ways to reduce the side effects.
The 10-year Japanese government bond yield currently fluctuates between around plus and minus 0.2%. The revised range is “between around plus and minus 0.25%.” It is said that if the yield moves wider, it is easier for banks to gain revenues from government bond trading.
Negative interest rates have hit banks hard, and there have been arguments that it would be difficult to lower interest rates further.
In its policy review, the BOJ stressed that it could cut interest rates further, and if it does, it will apply a premium interest rate to the current account balances that financial institutions have with the central bank.
To prevent banks from being reluctant to lend, the amount to be received will depend on the balance of the BOJ’s lending program to financial institutions, which was set up to encourage lending to businesses and other institutions.
The upper limit of about ¥12 trillion per year for ETF purchases was retained, but the lower limit of about ¥6 trillion per year in principle was removed. The aim of reducing purchases during periods of market stability and responding to emergencies is appropriate.
The purchase of ETFs began in 2010, and as the quota expanded, the balance of holdings ballooned, reaching nearly ¥50 trillion in market value at the end of February. It is believed that the central bank has become the largest shareholder in Japan.
The BOJ’s ETF purchases involve buying all the constituent stocks of an index, which is different from the fundamental concept of investment where decisions are made based on a company’s performance and growth potential, among other factors. There are fears that the BOJ’s ETF purchases have been undermining the functioning of the stock market.
The government should focus on measures to increase the number of shareholders to replace the BOJ, such as attracting household financial assets to the stock market.
— The original Japanese article appeared in The Yomiuri Shimbun on March 20, 2021.
