BoJ’s Message Shows How Markets Keep Bullying Central Banks

The immediate market reaction to a new Bank of Japan policy signal illustrated, once again, the dilemma that central banks, led by the Federal Reserve, have created for themselves over two decades. While few central bankers seem willing to take the risk and play the role that Paul Volcker did in the early 1980s to break an inflationary spiral, all should be mindful of something that is as true today as it was then: Lasting financial stability requires genuine economic stability, and vice versa.

Due to “financial and capital markets at home and abroad being extremely volatile,” BoJ Deputy Governor Uchida noted early Wednesday that the central bank “needs to maintain monetary easing … for the time being.” This signal, which I suspect was partly in response to external nervousness about global stock losses, was seen as pro-risk by markets; Bloomberg reported that hedge funds and other “fast money” accounts rushed to place new carry trades funded by the Japanese currency. The yen plummeted, dropping by 2%.