More On Japan
David R Kotok
February 4, 2016
The bullets below have been extracted from the January 29, 2016, release by the Bank of Japan (BOJ), entitled “Introduction of ‘Quantitative and Qualitative Monetary Easing with a Negative Interest Rate.’” In the piece that follows, I will summarize the BOJ’s extraordinary policy.
We expect the entire array of debt instruments issued by the government of Japan to transact at an eventual interest rate of zero or lower. Thus Japan can finance itself with the assistance of its central bank at no interest cost and without reasonable limits. Deficits don’t matter; interest rates don’t matter; and the capacity to finance is without limits until some market reaction occurs to alter this mix.
Japan is the third largest economy in the world, and it is a mature capital market system. It has an active stock market with companies that are engaged in global finance and commerce. Furthermore, Japan operates with a system that discourages activist influences from affecting its corporate and business culture. It also has an aging demographic.
The BOJ’s new policy means that the force of subzero interest rates will be applied to an economy where rates have been near zero for two decades and where attempts to reignite inflation have been singularly unsuccessful. The BOJ’s inflation target is a sustainable 2%, but they have been unable to reach that level for two decades.
You will see BOJ allocations to buy an ETF of stocks and a basket of REITs, in addition to debt instruments of various types. It is still difficult to assess the effects of these extraordinary Japanese measures, coupled with equally remarkable negative-interest-rate policy measures being implemented in Europe, on interest rates and inflation pressures in other mature and maturing economies around the world. We now have a situation where one-fourth of global GDP is produced in 23 countries that are trading with a negative-interest-rate policy.
Excerpts of key points from the BOJ release are listed below in bullet form, along with a link to the full release.
- The Policy Board of the Bank of Japan decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” in order to achieve the price stability target of 2 percent at the earliest possible time. Going forward, the Bank will pursue monetary easing by making full use of possible measures in terms of three dimensions; quantity, quality, and interest rate.
- The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank. It will cut the interest rate further into negative territory if judged as necessary.
- A negative interest rate of minus 0.1 percent will be effective from the reserve maintenance period, which commences from February 16, 2016.
- A multiple-tier system is intended to prevent an excessive decrease in financial institutions’ earnings stemming from the implementation of negative interest rates that could weaken their functions as financial intermediaries. Multiple-tier systems are adopted in countries where the size of negative interest rates is relatively large, including Switzerland (minus 0.75 percent), Sweden (minus 1.1 percent), and Denmark (minus 0.65 percent).
- The Bank of Japan will conduct money market operations so that the monetary base will increase at an annual pace of about 80 trillion yen.
- With a view to encouraging a decline in interest rates across the entire yield curve, the Bank will conduct purchases in a flexible manner in accordance with financial market conditions. The average remaining maturity of the Bank’s JGB purchases will be about 7–12 years.
- The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.
- The Bank will continue with “QQE with a Negative Interest Rate,” aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.
- As before, the Bank will not set a lower bound for yields on its JGB purchases. Thus, the Bank can carry out outright purchases of JGBs with negative yields lower than minus 0.1 percent.
- In addition to the current program of ETF purchases, the Bank will commence purchasing ETFs under a new program from April 2016 at an annual pace of about 300 billion yen, which was decided at the Monetary Policy Meeting on December 17 and 18, 2015. Under this new program, the Bank will purchase ETFs composed of stocks issued by firms that are proactively investing in physical and human capital.
David R. Kotok, Chairman and Chief Investment Officer, Cumberland