The Way the World Thinks About Easy Monetary Policy Is Changing

The side effects of quantitative easing are under fresh scrutiny.

Goncalves: BOJ Not Admitting QE Doesn’t Work

It happened so quickly.

While analysts and economists had long debated the efficacy of quantitative easing — the central bank bond purchase programs aimed at lowering borrowing costs to stimulate the economy and stoke inflation — the narrative surrounding such efforts is rapidly shifting. In recent months, there's been a growing recognition of the limits and downsides to this particular form of monetary easing, underscored by the Bank of Japan's policy changes announced on Wednesday.

Some 15 years after first experimenting with QE, the BOJ announced that it intends to shift the focus of its policy framework to better finesse borrowing costs by, in effect, anchoring longer-term rates higher, and moving away from a rigid target for expanding the money supply. While market participants expect the central bank to further expand bond purchases and take the rate on a portion of bank balances deeper into negative territory in upcoming meetings, the BOJ's move is a recognition that its daring strategy to dramatically expand the money supply to fight deflation has delivered a blow to the financial sector's profitability.

"The biggest takeaway here is that the BOJ is now leading the world into a new era of central banking and is essentially making long-term interest rate, 10-year Japanese government bond yields a focal point in its central banking platform instead of negative interest rate policy," analysts at TD Securities Inc. led by Mazen Issa, wrote in a note today. "The yield curve control program is an interesting but untested concept. It is one attempt to provide relief for pension funds, [life insurance companies], and banks."

The program announced on Wednesday helped propel Japanese lenders' stocks higher, underscoring the evolution in easy monetary policy. The BOJ plans to buy enough 10-year government bonds to keep the yield close to zero percent, while potentially purchasing fewer longer-dated bonds, in a move expected to boost profits for the financial sector and encourage them to lend and invest.

The Bank of Japan had doubled-down on its QE program in February with the surprise introduction of a negative interest-rate policy on a portion of bank reserves, sharply lowering long-term rates — as well as bank stock prices — amid a squeeze on net interest margins for lenders.

Despite the shock-and-awe strategy early in the year, the yen appreciated in the aftermath of the move, while deflation risk remains unabated — with CPI at minus 0.5 percent year-on-year in July — and long-term inflation expectations remain stubbornly low.

Though the BOJ has maintained the minus 0.1 percent charge on some bank balances, its yield-curve commitment — similarly deployed by the Federal Reserve from 1942 to 1951 to lower the U.S. Treasury's post-war financing costs, but which remains unprecedented in modern times — represents a sea-change in the central bank's thinking.

The BOJ's newfound embrace of a yield-curve target is a belated recognition that NIRP can negatively impact financial intermediation and inflation expectations, say analysts.

"The good news is that BOJ has finally acknowledged that NIRP does have some negative impact on intermediation and potentially on inflation expectations – which the BoJ puts at the center of its policy goal," Morgan Stanley economists led by Takeshi Yamaguchi wrote in research published last week, for instance. "The fear is that this negative impact will wax and positive impact wane. Once the evidence is clear, the result may already have had serious adverse consequence for the real economy."

Hans Redeker, strategist at the U.S. bank, reckons a negative-yielding flat yield curve has reduced monetary velocity and pushed the yen higher, while a steeper yield curve — allowing financial intermediaries to borrow at low rates and invest at longer maturities — might unleash the animal spirits needed to increase risk-taking.

In a report last week, amid indications from officials that the BOJ would anchor long-end yields higher, Redeker wrote: "Financial sector balance sheets have been dismissed by central banks for too long," adding that the central bank's newfound focus on financial-sector profitability represents a belated recognition of banks in aiding the transmission of monetary policy to the real economy.  

Tomoya Masanao, head of Japanese portfolio management at Pacific Investment Management Co LLC, in a research note last week, called on the BOJ to scale back JGB purchases at the long-end to steepen the yield curve and aid financial intermediation, arguing that negative long-end rates had facilitated the refinancing of existing debt rather than stimulating new productive investments.

Bankers argue low longer-dated yields and negative rates deliver a blow to their return on assets, offsetting the benefits of lower funding costs — and the BOJ's apparent capitulation might embolden critics of monetary policy in other advanced economies. 

Questions over the effects of QE have already extended away from policymakers at the BOJ. In the U.K., Monetary Policy Committee Member Kristin Forbes suggested in the aftermath of the Brexit referendum that further easing could end up tightening financial conditions rather than loosening them.

"People will earn less on their hard-earned savings — potentially cutting back on spending to reach a target savings pot. Banks will make less money on lending," she wrote in an op-ed. "Pension and life insurance funds will have a harder time meeting their commitments. Companies may need to put more money into pension schemes — leaving less to spend on workers and investment."

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