On April 20, 1018, the IMF presented its – Asia and Pacfic Department Press Briefing – in conjunction with the release of the April 2018 World Economic Outlook and the upcoming (May 9, 2018) release of its Asia and Pacific Regional Economy Outlook. The Deputy Director of the Asia and Pacific Department, one Odd Per Brekk, told the audience that Japan should continue its Quantitative Easing (QE) program and maintain transparency in its purchase volumes so as to ensure the strategy to accelerate the inflation rate up to the 2 per cent target is achieved. Part of this strategy involves shifting inflationary expectations from their recent low levels. Critics of the program shriek that the asset base of the Bank of Japan is now approaching the nominal GDP level and given that a high proportion of those assets are comprised of Japanese Government Bonds, that reversing the strategy eventually will be difficult and risks involving the Bank is huge losses, which might render it insolvent. Insolvency has no application in the case of a central bank which can never go broke. Further, the Bank never needs to reverse the QE purchases. There is no relevance in the rising assets to GDP ratio. The problem is that QE will not achieve the desired end. The Bank has expanded its QE program significantly yet the inflation rate and inflationary expectations remain well below the 2 per cent target. They will eventually work out that the mainstream theory that predicted otherwise is erroneous.
Mr Brekk indicated that “Japan has actually been a bright spot in the global economy over the last couple of years” and had “grown above potential for … more than two years now”.
He said this growth was due to “external demand as well as some more fiscal stimulus than we expected”.
He indicated that:
The growth drivers in 2018 in Japan include private investment, which is expected to increase, also due to the Olympics in 2020. And, as I said, a favorable external environment will also likely continue to underpin solid export growth with spillovers to investment and imports.
He also gave an assessment of “Abenomics at the five-year mark” and indicated that the fiscal strategy “has clearly delivered results in terms of incomes and employment including higher labor force participation of women and elderly workers, the strongest growth in employment record for the last two decades, if not more.”
In terms of inflation – he noted “the gradual increase that we have been seeing in inflation over the last year or so” and that “you have to realize this was never going to be a sprint given Japan’s decades long stagnation, but rather a sustained effort to change mindsets and practices”.
In other words, the IMF was urging the Bank of Japan to continue to maintain its huge “monetary stimulus” in order to increase the inflation rate, which is languishing at around half the Bank’s stated target.
Mr Brekk told the press (Bloomberg) after the briefing that (Source):
The message has to be the commitment to reaching the 2 percent inflation target and to put in place the policies needed to get there …
Monetary policy in Japan is very much focused on changing expectations. The main challenge facing the Bank of Japan is to re-anchor inflation expectations at 2 percent … From that point of view, communication by the Bank of Japan on the commitment to stay the course is the right one …
Moving fully to the yield curve control framework would help strengthen the message that you can sustain and that you will sustain an accommodative monetary stance.
The reference to “moving fully” is in the context of the bank stating that it will continue to increase its Japanese government bond holdings annually by around 80 trillion yen, when in fact, in the recent past the purchasing rate has been around 50 trillion yen.
The Bloomberg reporting of the event chose to give air to alleged:
… worry about the sustainability of the BOJ’s policies given the 2 percent inflation target remains distant and the size of its balance sheet is approaching that of the nation’s annual economic output.
The relevant graph that follows is the Total assets held by the Bank of Japan as a per cent of GDP (blue line) and the proportion held as Japanese Government Bonds between the March-quarter 2000 to the December-quarter 2017.
In the December-quarter 2017, total assets stood at 94.5 per cent of GDP (and JGB holdings were 80.2 per cent of GDP).
Why this particular statistic matters is beyond me but apparently the “critics” think it matters.
The point of this blog post is to emphasise that it doesn’t matter one iota and that it rapid acceleration since the Bank of Japan started buying JGBs in large volumes in order to increase the inflation rate demonstrates how ineffective monetary policy is in influencing the path of the inflation rate, despite the massive increase in central bank assets.
Inflation is still benign in Japan
The latest data from Japan’s e-Stat service (released April 18, 2018) for the Consumer Price Index, March 2018 – shows that the:
1. All items rose by 1.1 per cent annually but was down 0.4 per cent on the month to March 2018.
2. Excluding the volatile items (fresh food and energy) the annual inflation rate was only 0.5 per cent and the monthly fall was 0.1 per cent.
In other words, the annual inflation rate is still around 50 per cent of the Bank of Japan’s stated target.
It CPI index hasn’t changed much since the mid-1990s.
A long way to go in other words.
The following graph shows the history of Japanese inflation since 1970.
QE history in Japan
The Bank of Japan’s quantitative easing history began in earnest in March 2001 (QE1) and this increased the BOJs monetary base by around 60 per cent.
You can see that in the first graph above.
The Bank terminated that program in March 2006, whereupon the Bank sold down its holdings (also shown in the graph).
A second (QE2) program began in October 2010 and as time has passed it has become QE3, which is a much larger scale intervention that that began in April 2013.
Another way of looking at the relationship between monetary policy changes in Japan and the evolution of the inflation rate is shown in the following graph. The shaded blocs are the three QE periods during the sample shown.
I indexed the monetary base and the Consumer Price Index to 100 in January 1990.
The graph shows the evolution of these indexes up to March 2018.
The monetary base index was at 1200.5 in March 2018, while the CPI was at 332.7.
The overwhelming conclusion is that there is no relationship between the evolution of the monetary base (driven by the Bank’s purchases of JGBS in large volumes) and the evolution of the inflation rate.
One could argue that the reversal of QE1 revealed a lack of commitment by the BOJ to really drive the inflation rate up. My assessment is that QE doesn’t work whether it is extended for lengthy periods or not.
The reversal that followed the introduction of QE2 just reduced the monetary base (and the total assets held by the BOJ).
The latest data on inflation expectations is also indicative that the QE policies are not having the desired effect.
New Keynesian suggest that prices are adjusted to accord with expected inflation. With rational expectations, the mainstream models predict that inflation will respond one-for-one with shifts in expected inflation.
The Bank of Japan has been trying to manipulate that ‘theoretical claim’ in real space through its QE experiments.
The following graph is taken from the – Tankan Summary of “Inflation Outlook of Enterprises – the latest data being released on April 2, 2018, covering expectations up to March 2018.
Firms are asked to assess the future price movements in output prices and consumer prices.
The first graph shows the outlook for output prices – 1-year ahead, 3-years ahead and 5-years ahead.
While the expectations have risen in recent months, that is more the result of increased output growth. In the early periods of QE3, the expected inflation rate for output prices fell sharply.
The second graph shows the outlook for consumer prices – 1-year ahead, 3-years ahead and 5-years ahead. It also includes the actual inflation rate (Purple line).
Again it is hard to see any substantial movement in consumer price expectations.
While the Bank of Japan can accumulate JGBs in whatever volumes they choose and can never go broke if the price of those bonds in the secondary markets create “losses”, the policy will not deliver the inflationary spike that the IMF and the Bank is seeking.
Inflation will accelerate if fiscal policy pushed the growth rate and the demand for real resources above the potential growth rate and the resource availability.
QE is a sideshow.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.