Bank of Japan Pushing on a String as Shrinking Economy Needs Tow

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Just as the Bank of Japan most needs to revive a contracting economy, the effectiveness of its monetary policy is at a record low.

The money multiplier, a gauge of activity generated when the central bank eases, fell to 3.92 last month, the lowest in data dating back to 2003. That’s even as BOJ debt purchases of as much as 12 trillion yen ($97 billion) a month caused the monetary base to balloon about 150 percent. The phrase “pushing on a string” was adopted during the 1930s Great Depression to describe the difficulty in reviving demand with fund injections.

“Money isn’t flowing into the real economy, it’s just moving between the BOJ and banks as Japanese government bonds are transferred to the BOJ’s excess reserves,” said Takafumi Yamawaki, the chief rates strategist in Tokyo at JPMorgan Chase & Co. “The main spill-over effect from the unprecedented easing is to lower long-bond yields and a weaker yen.”

The world’s third-largest economy contracted last quarter as a slump in private-sector demand coincided with declining exports, further challenging BOJ Governor Haruhiko Kuroda’s efforts to meet the 2 percent inflation target with record stimulus. The benchmark 10-year JGB yield is heading for its first quarterly drop since December, declining 8 basis points to 0.375 percent since June 30, amid expectations the monetary authority will have to pare its economic forecasts.

Falling Lending

The money multiplier is derived by dividing the money stock representing funds that are circulated in the economy by the monetary base, which is the liquidity the BOJ pumps into the financial system.

The monetary base grew 2.5 times through July since November 2012, a month before Prime Minister Shinzo Abe took office, vowing to pursue reflationary policies to end deflation. That far outstripped the 8.5 percent increase in the money supply to more than 1 quadrillion yen in the period.

The proportion of lending to deposits is also falling, signaling that money is not filtering widely through the economy. The rate stood at 0.6714 in July, near a record low 0.6685 touched in May, according to Bloomberg-compiled data based on BOJ figures.

Longer-dated JGBs have risen along with global bonds amid concerns that China’s economic slowdown would weigh on other economies and depress commodity prices.

Faltering Growth

Japan’s gross domestic product fell an annualized 1.6 percent in the April-June period, ending two quarters of growth.

The data added to doubts about the BOJ’s ability to foster stable 2 percent inflation by the end of its target period in September 2016.

“The GDP data may have bolstered the case for additional easing,” said Hideo Kumano, an economist at Dai-ichi Life Research Institute and a former BOJ official. “No matter how much the BOJ boosts the monetary base, money stock isn’t growing much. The problem is that money isn’t spent to take investment risks.”

Despite low interest rates and record corporate profits, capital investment is lagging due to slack domestic demand, said Toru Suehiro, an economist at Mizuho Securities Co.

“The BOJ is likely to revise down the growth outlook in its report in October and ease further at the same time or in January,” he said. “There are tailwinds for the JGB market.”

Suehiro said he expects the 10-year JGB yield to stabilize around 0.4 percent to 0.5 percent.

‘Shock Therapy’

The effectiveness of monetary policy is conditional on various government measures aimed at expanding the economy, said JPMorgan’s Yamawaki.

Japan’s export growth slowed in July, a sign that foreign demand is failing to provide much support to the economy, government data Wednesday showed.

The country needs an economic injection of as much as 3.5 trillion yen to shore up consumption and stave off a further economic contraction, said Etsuro Honda, an economic adviser to Abe.

Sixteen of 37 economists forecast the BOJ won’t expand monetary stimulus further, the most popular answer in the survey conducted July 27 - Aug. 3. Twelve expect the bank to add stimulus at the meeting on Oct. 30, unchanged from last month.

“The quantitative and qualitative easing was an effective shock therapy but it’s different from here on,” Yamawaki said. “The BOJ should start debating tapering from next summer or fall and begin to implement that a year later. It should shift to a flexible stance on the inflation target at some point.”

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