Japan will remain the new normal

Greetings. The big news in central banking this week was the Bank of Japan’s move to lift its short-term interest rate above zero and stop targeting long-term rates altogether. There has been a lot of reaction, mostly in the form of a sigh of relief at “the end of the global experiment with negative interest rates”, in the words of the Wall Street Journal. As I spell out below, this misses the point in many ways.

But first, let’s check in on the latest news on a topic I am quite relentless about here at Free Lunch: how to make Russia pay for its destruction in Ukraine. (ICYMI, my most recent analysis was in last week’s column.) Josep Borrell, the EU’s foreign policy supremo, claims support from the bloc’s foreign ministers for using most of Euroclear’s profits from blocked Russian state assets on weapons for Ukraine. Predictably enough, Moscow makes noises — which some Europeans unfortunately believe, too — that a windfall tax on a Belgian company will damage the credibility of the euro.

Let’s first get one thing out of the way: there isn’t much important to be said about the BoJ’s new monetary stance itself. It is a negligible shift for a central bank to raise the short-term target from minus 0.1 per cent to a zero to 0.1 per cent range, and abandon a cap on long-term rates only to promise to counteract any “rapid rise” in them and continue to buy long-term bonds in the same amount as before. For the details, read the FT’s reporting on the decision or the BoJ’s own six-page statement.

For reasons I set out below, I also think it’s unfortunate to greet the shift from just below to just above zero as somehow symbolic or different from any other 0.1 to 0.2 percentage point tightening. Instead, I think the policy move is an opportunity to reflect on how quietly influential Japanese monetary policy has been on the rest of the world for the last quarter of a century.

The BoJ was not the first to introduce negative interest rates (that was, briefly, Sweden, and later Denmark and the European Central Bank). But it pioneered ZIRP — zero interest rate policy — and was long seen as an aberration, a monetary cabinet of curiosities of sorts, for doing so.

The exoticisation of Japan went beyond the central bank to the whole economy, which was long seen in the west as an idiosyncratic case whose bizarre economic phenomena — persistently weak inflation, a shrinking working-age population, slow growth and public debt accumulating beyond anything anyone thought sustainable — could happen in theory but not, anywhere else, in practice. Few expected that within a decade or so, every country would look Japanese. Nor did they expect that apart from foreshadowing the problems, Japanese policymakers would also prepare many of the solutions.

In his fabulously titled 1998 article (“It’s Baaack!”), Paul Krugman analysed Japan as suffering from a 1930s-style “liquidity trap”. This is a situation where interest rates hit zero, and further monetary stimulus has no effect. Because — so it is assumed — interest rates cannot go below the “zero lower bound”, any additional money issued by the central bank is simply hoarded by savers, without creating additional incentives for investment or consumption. The implication is that monetary policy becomes impotent (like “pushing on a string”) and only fiscal stimulus can get the economy back to growth.

The premise of the argument was, of course, wrong. Central bank interest rates can go negative, and all the arguments against them have proved unconvincing. Central banks including the BoJ have shown that one can remove the incentive to hoard cash to avoid negative rates by applying different rates to different “tiers” of commercial banks’ reserves. And as the ECB’s own assessment shows, taking interest rates below zero has pretty much the same effects as lowering rates while they are still positive. Rate cuts below zero are, in other words, just rate cuts. The specialness of zero was always a superstition.

The BoJ’s role in demonstrating this is largely, but not entirely, positive. By going to zero first, Japanese central bankers made it easier for others to follow suit, putting other central banks on the threshold of breaking through the supposed zero “bound”. What is more, ZIRP was not the BoJ’s only contribution to the central banking arsenal. It pioneered large-scale government bond purchases, or “quantitative easing”, as well. After the 2008 global financial crisis, QE became so widely practised that we can hardly call it “unconventional” anymore. And while most major central banks, unlike the BoJ, are now working on how to reduce their bond holdings (in other words, quantitative tightening), the expectation is that they will permanently maintain larger balance sheets than before the GFC, and whip out QE again whenever they see fit. In this sense, the BoJ’s exotic experiments changed central banking forever.

But the BoJ itself was late in daring to adopt negative rates proper, and it never went further than negligibly below zero. This, as well as the turn to QE as an alternative, buttressed the notion that there is, if not a zero lower bound on central bank rates, then a lower bound just below zero. The obvious, if patient, desire with which even the BoJ has wanted to “normalise” monetary policy, meanwhile, has reinforced the global tendency to “denormalise” what should be seen as standard.

That’s not the end of the BoJ’s contributions, however. It has demonstrated how creative one can be with asset purchases (it talks of “qualitative” as well as quantitative easing), and has been buying not just government bonds but stock market funds and real estate-linked securities (it ended both programmes in this week’s decision). Most significantly, it implemented “yield curve control”, which in practice meant using conventional market intervention tools to fix the yield on 10-year government bonds (rather than the standard short-term rate on the shortest-term government securities).

Unlike plain-vanilla QE, hardly any other central banks have copied these innovations. That was a wasted opportunity. The big-picture takeaway from the BoJ’s experience is surely that the policies worked as intended with few bad side effects. If anything, YCC worked better than plain QE in the sense that the BoJ ended up having to buy bonds at a significantly slower pace to achieve its desired monetary policy stance.

As I have argued before, there was no need in particular to end YCC; the BoJ could instead have continued to adjust the target upwards if it wanted to tighten policy. In a world of several desirable policy objectives, giving up additional instruments is an unforced error. But on the bright side, the BoJ’s demonstration that these tools could be used will lower the threshold for others needing them in the future.

That may include the BoJ itself, of course. As my colleague Robin Harding explains, all the structural causes of low inflation and naturally low interest rates in Japan remain. And much the same can be said for other advanced economies, if not to the same extent. It is far from clear that long-term equilibrium rates will be much higher than before the huge disruption of Covid-19 and Russian President Vladimir Putin’s assault on Ukraine and his energy war. To the extent the BoJ has demonstrated the many tools at central bankers’ disposal, it deserves huge thanks. To the extent it has supported the astonishingly widespread aversion to using these tools as something weird or unnatural or undesirable, it does not.

So that’s my biggest takeaway: the very fact that observers without irony speak of “escaping” from negative interest rates is itself a manifestation of a big problem. Those who think they no longer live in a Japanese world are deluding themselves.

Other readables

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• Universal basic income programmes are spreading throughout the US, and Republicans are trying to outlaw them. (Not sure what UBI is? Watch the video we made about it.)

• Great investigative journalism in a collaboration between the FT and a Danish outlet: Russia’s oil tanker fleet, built up to circumvent sanctions, travels through western waters without the required disaster insurance.

• European economists make bold proposals for a unified EU energy policy.

• The EU’s financial services commissioner wants progress on the bloc’s capital markets union. The FT’s Editorial Board has called on EU leaders to stop dithering.

Numbers news

• Russia’s growth is slowing and production volumes in the main sectors may even have fallen slightly, estimate the Bank of Finland’s Russia-watchers.

  

• Old problems are back, and will no doubt be celebrated as achievements: the eurozone hit a record trade surplus in January.