The Finance minister of Japan said that it is early
for Japan to consider exiting from its Quantitative Easing Policy. The Japanese
economy is just exiting a 15 year deflation period. To cure economic ills of Japan, which in 2007 had
a GDP of -2.3%, manufacturing output, was at -12.1%, CPI -1.1%, the monetary
policy Japan decided to follow was an aggressive one. That is, monetary and
interest rates.
Ever since, the BOJ (Bank of Japan) has followed a
policy similar to the US FED: low interest rates. However the transmission
mechanism of low interest rates did not reach the real economy since households
and businesses did not borrow. Instead they saved.
The central bank created money by buying bonds from
banks. This gave rise to liquidity in the balance sheets of Japanese banks. For
Japan this accounted for 25%. In terms of fiscal policy this added to the GDP
(4.9%), thus for Japan it was an expansive fiscal policy.
This policy of Open Market Operations, on the one hand
provided liquidity for banks, on the other, they held on to it. This aggressive
policy by the Japanese central banks, to buy government bonds in more quantity,
to provide reserves for commercial banks, provided the central bank with 30% in
bonds (of GDP) in assets.
A decline in Quantitative easing, (which the finance
minister of Japan said it will continue) is beneficial to state governments because
this decreases demand thus, interest rates drop, and therefore, the cost of
borrowing for the governments decreases. This, in turn, is not good for bond
investors since the returns are low.
In recent articles I have described how central banks
try to mix their policy in terms of looking only at GDP, or both inflation and
GDP. The BOJ is targeting an inflation of 2%, so the finance minister said that
interest rates’ decline, will depend on whether the central bank has set its
target of inflation.
Japan has had deflation for a long time and one of the
reasons for an aggressive monetary policy is to bring its economy out of deflation.
Deflation is the general decline in asset prices caused by the reduction in the
supply of money - credit. It can also be caused by the government in its
reduction in fiscal policy, like spending, public investments. This causes high
levels of unemployment and an economic depression.
Japan is trying to deliberately induce rising prices
by an aggressive monetary policy and cause inflation.
