BoJ renaissance threatens to join Fed and leave ECB as laggard, say UBS economists

Joshua McCallum, senior fixed income economist at UBS Global Asset Management, and colleague Gianluca Moretti, fixed income economist, see a renaissance at the Bank of Japan.

Under its new governor, Haruhiko Kuroda, the BOJ has finally changed course. Japanese QE now follows the Fed model: there is one QE programme, bonds will be bought across the curve and buying will continue until the central bank thinks that its objectives will be achieved. With the BOJ moving from being the laggard to becoming more like the Fed than the Fed, the ECB has now become the laggard and, unless it can bring about any new surprises, it will end up looking a lot like the old Bank of Japan.

By any reasonable measure, up to now the Bank of Japan (BOJ) had failed as a central bank. To be fair, faced with demographic reversal and structural rigidities, the task that it faced during the ‘Lost Decade’ and beyond was not an easy one. Nonetheless, after trying half-heartedly to stimulate the economy with quantitative easing (QE) in 2001 it gave up and reversed a few years later. It is one thing to get a ‘fail’ for dealing with difficult challenges, it is quite another to get a ‘fail’ for effort. Under its new governor, Haruhiko Kuroda, the BOJ has finally changed course.

Up to now, the post-crisis QE efforts by the BOJ had been half-hearted at best. It only (re-)started QE much later than the others, the duration of the purchases was kept very short (limiting the impact on the long end of the yield curve), there were multiple programmes, and it came up with a strange and economically unfounded rule that limited bond purchases to the equivalent of the amount of notes and coins in circulation. Governor Kuroda has swept all these complications aside and replaced them with something simpler, larger and likely to be far more effective.

Japanese QE now follows the US Federal Reserve (Fed) model. There is one QE programme, bonds will be bought across the curve and buying will continue until the central bank thinks that its objectives will be achieved. There is one crucial difference, however: the BOJ will be printing money and buying bonds at twice the rate that the Fed is doing so (relative to their GDP). On current trajectories, the BOJ QE programme will surpass the Fed’s by the middle of this year and even surpass the more aggressive Bank of England by the second quarter of next year (chart 1). Take note, however, that the slower pace in the US could be partly due to QE being successful: US nominal GDP is growing at 4% while nominal GDP in Japan has been shrinking.

The BOJ has also adopted the 2% inflation target that is the benchmark for almost every other central bank. Given that CPI is currently at -0.7%, this is no small challenge. In general, inflation has only been positive because of energy
and food prices jumping around. Stripping out that effect, within the last 15 years the core underlying rate of inflation has only been above zero for a few months in 2008. It should come as no surprise that deflation expectations are firmly entrenched.

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