The reason for this historical medical walk is that today’s central bankers, for all their impressive equations and studies, have more in common with these doctors of long ago than they would like to think. When bloodletting didn’t work, the remedy was often more bloodletting. For the modern central banker, the answer to almost everything that has gone wrong over the past two decades has been looser monetary policy—that is, ever-lower short-term and long-term rates. But it turns out that their theories often rested on shaky foundations, and in some cases the evidence strongly suggests that instead of boosting economic growth and inflation, their activities did the exact opposite. Nowhere is this more true than in Japan, despite the reassuring avuncular certainty of Haruhiko Kuroda, the Governor of the Bank of Japan.
The BOJ resisted again this week, although it was not a surprise: it has not changed its policy for years. Kuroda got his job in 2013 as the archer of Shinzo Abe’s third arrow: ultra-loose monetary policy. Not wanting to send short rates too negative, the BOJ started buying Japanese government bonds in 2013 and formalized this in 2016 with a yield curve control policy that it would not leave rates at 10 years exceed a defined level, currently around 0.25. %. It now owns more than half of all publicly issued government bonds. Under Kuroda, the BOJ also started buying stocks. He now owns about $430 billion in Japanese stocks. Its balance sheet now equals 135% of gross domestic product. No other major central bank has a balance sheet of this size relative to its economy.
While I suspect Abe’s assassination will at least have heightened the BOJ’s desire not to falter, there is no evidence that this frantic activity had the intended effect of boosting activity and inflation. The recent pick-up in Japanese inflation was entirely imported. At the national level, evidence suggests that the BOJ’s activities are making things worse, not making them better. When central banks lower interest rates, the idea is that households and businesses will spend more and save less, which will stimulate activity. In fact, however, Japanese companies have continued to save at a similar rate, meaning they are investing less than their net profits. Much more strikingly, the Japanese household savings rate has climbed relentlessly. The only way for Japan not to fall into an economic black hole is if all this private saving is matched by huge public spending.
Why would households have increased their savings? One reason is that Japan is not like textbook savings. It is literally the oldest country in the world and it is aging rapidly. The average Japanese citizen reaches 50 and can expect to live to 85, although Germans and Italians are not that far behind. Also, the population is shrinking partly because Japanese families don’t have enough children and partly because Japanese people don’t like foreigners too much. Evidence suggests that when interest rates are reduced, Japanese people save more, not less. From this perspective, paradoxically, lower interest rates tighten monetary policy and higher interest rates loosen it. This explanation is at least consistent with what actually happened rather than what the BOJ would have liked to happen.
It’s getting worse. Alone among major central banks, the BOJ stayed on its heels and did nothing on interest rates, and the yen fell. Although Kuroda argued that the problem was a strong dollar, that’s simply not true: the trade-weighted yen has fallen sharply over the past two years. Add the weak yen to skyrocketing commodity prices, and the result is a huge terms-of-trade shock, crushed corporate margins and a massive trade deficit. The only reason Japan still has a current account surplus is because it has such a large stock of overseas investment. I don’t see any of those animal spirits reviving.
All of this is remarkably visible and disturbing, that’s for sure. Less visible and more worrisome, Japanese policymakers do not believe there are costs to controlling financial markets to the extent that they do. Although the BOJ controls the markets more than any other major central bank, all have taken the same path and are only reluctantly and slowly turning to another. You don’t have to be a market fanatic to care. Developed economies need more productivity growth, Japan more than most. We had, I thought, learned that, whatever their faults, markets allocate capital better than bureaucrats. Nothing the Bank of Japan and others have done in recent years suggests otherwise.
More writers at Bloomberg Opinion:
• What good is hiking when the recession is looming? : Gearoid Reidy
• The absence of inflation in Japan linked to an accommodative policy: Richard Cookson
• BOJ seems to relish stubborn isolation: Moss and Reidy
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Richard Cookson was Head of Research and Fund Manager at Rubicon Fund Management. Previously, he was Chief Investment Officer at Citi Private Bank and Head of Asset Allocation Research at HSBC.
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