Helicopter money: credible irresponsibility in Japan?

Steve Donzé and Hiroshi Matsumoto are respectively senior macro strategist and head of Investment Management Japan at Pictet Asset Management.

The recent rally in the yen is casting a dark cloud on the Japanese economy as fears grow that the Bank of Japan is running out of ammunition to boost growth and lift inflation. The central bank has yet to deploy its most powerful and perhaps most controversial tool – helicopter money – one which is sure to lift inflation but tip the BOJ into a technical insolvency.

The Bank of Japan is at a crossroads. Its quantitative and qualitative easing (QQE) programme, in operation since 2013, has failed to either push inflation towards its 2 per cent target or raise inflation expectations.

Its surprise shift to negative interest rates in January was equally unsuccessful, doing nothing to arrest a recent decline in consumer prices, which in May fell at their fastest pace in three years.

To make matters worse, Japan’s economy is facing a new foe in the shape of Brexit. Pressure is consequently rising on the BOJ to roll out yet more monetary stimulus. The problem is that doing more of the same will not work.

Helicopter money is not without its risks. Negative equity and the possible loss of financial independence may hurt a central bank’s credibility and raise doubts about its ability to deliver on policy targets.

However, we think that the BOJ’s failure to reach the inflation target has already damaged its reputation. Helicopter money is a way for it to repair that damage.

In the near term, we expect the BOJ to widen the scope of its QQE, by buying more ETFs and J-REITs. However, such a policy cannot continue indefinitely.

By 2020 at the very latest, the BOJ’s quantitative easing will have reached a critical stage, threatening the smooth functioning of capital markets. At that point, the BOJ will have no choice but to resort to helicopter money.

In our view, it is far better for the BOJ to act sooner rather than later.

A debt write-off is a way for a central bank to commit even more credibly to the promise of permanent money creation. Once the market starts to price in this probability, however small it is, inflation expectations should begin to move up, leading to higher asset prices.

By deploying helicopter money, the BOJ will demonstrate that it has a plenty of effective policy tools. In doing so, Japan will open the door to a new era of unorthodox monetary policy making.

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