Wednesday, 6 October 2010

More like zip than ZIRP

Yesterday's monetary policy easing by the Bank of Japan was presented in some press reports and blog posts as a return to the zero interest rate policy (ZIRP) that Japan tried from 1999 to 2000, and again from 2001 to 2006. No doubt the press were guided by the official post-decision statement, which described the policy as a "virtually zero interest rate policy". RebelEconomist is not convinced.

To be precise, the new policy is to guide the inter-bank uncollateralised overnight call rate to a range of "0 to 0.1%", compared with its previous target of "around 0.1%" maintained since December 2008. However, as footnote 2 of yesterday's statement states, the interest paid on excess reserves under the BoJ's complementary deposit facility (originally introduced in October 2008) remains at 0.1%. As described in detail in an earlier post here, paying interest on reserves effectively sets a floor to interest rates in the inter-bank market, because it pays any bank with a reserve account at the central bank to accept loan offers below the interest rate paid on reserves and deposit the money with the central bank. Depending on the significance of inter-bank market participants without access to remunerated reserves, transactions costs and operational constraints (such as timing differences between the close of the inter-bank market and the latest transactions allowed with the central bank), arbitrage should not permit inter-bank interest rates to fall much below the rate paid on reserves. And indeed, a US Federal Reserve study of foreign central banks' experience with remunerated reserves by Bowman, Gagnon and Leahy published in March 2010 found that since the complementary deposit facility was introduced in Japan, the overnight call rate had never traded below 8 basis points. This suggests that yesterday's BoJ policy change represents a negligible easing in terms of short-term interest rates.

There was also another easing measure announced by the BoJ yesterday. The BoJ undertook to purchase outright ¥5tn (about $60bn) of longer-term government and shorter-term private sector bonds including commercial paper (CP), asset-backed commercial paper (ABCP), corporate bonds, Japanese Real Estate Investment Trusts (J-REITS) and exchange-traded funds (ETFs), partly to reduce term and credit/liquidity spreads respectively, and partly of course to supply additional base money in pursuit of the lower overnight call rate target. Of this ¥5tn, "about ¥3.5tn" ($42bn) is to be allocated to government bonds and treasury bills, and only "about ¥1tn" ($12bn) to CP, ABCP and corporate bonds. Compared with the BoJ's existing holdings of JGBs (presently ¥80tn or $960bn), the outstanding stock of JGBs (¥734tn or $8.3tn as of end-June 2010), or the total size of the Japanese bond market (about $12tn or ¥1100tn according to the BIS as of end-March 2010, of which $9.8tn comprised JGBs) the planned purchases represent modest amounts. A rough estimate of the likely effect on yields of these additional acquisitions can be derived by comparison with the estimated effect of the Fed's treasury purchases under its own quantitative easing program, as the size of the US treasury market ($10.0tn at end-March 2010) is of a similar size to the (then) $9.8tn JGB market. According to a recent Federal Reserve discussion paper by D'Amico and King, the Fed's purchase of $300bn of treasuries in 2009 generated a sustained fall in mid-curve treasury yields of about 50bps. Assuming a similar impact of BoJ purchases on the JGB market, the $42bn JGB purchase announced yesterday could be expected to reduce mid-curve yields by about 7bps only.

Overall therefore, yesterday's BoJ easing move is modest, and may have been designed as much as a concession to the BoJ's critics in government and industry as an attempt to stimulate the Japanese economy.


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JP Koning said...

Even the world's most independent central bank isn't that independent after all. As long as the executive branch can use the threat of changing the Bank of Japan Law to revoke independence, extracting policy changes in return, the BoJ is just another tool.

RebelEconomist said...

Of course you are ultimately right JPK, but at least such a change would be overt, and the elected government can be seen to take responsibility for it. An issue that is bothering me, however, is what seems to be a stealthy shift in central bank behaviour to a generally more dovish stance that is being introduced by the senior central bankers themselves, in tacit cooperation with their governments.

Although members of monetary policy committees (MPCs) may be independent of government once appointed, they are generally chosen either directly by, or at least with the approval of, government. Similarly, the promotion of an MPC member to a leadership position is also subject to government approval. Apart from exceptional circumstances in which a government expects to lose power and wants to leave a landmine for their successors, governments generally prefer a dovish central bank that errs towards easy monetary policy to favour short-term growth and support asset prices. I suspect that some academic and market economists with the qualifications and ambition to serve on the MPC now position themselves to signal a moderate if not dovish approach to monetary policy, in the hope of being appointed to the MPC or promoted to lead it. By contrast, known hawks or potentially hawkish mavericks are unlikely to be invited to serve, except perhaps the odd token appointment. In my view, a classic case of such a pitch was Bernanke himself, who I was sure would succeed Greenspan as Fed chairman after his "deflation" speech in November 2002, which emphasised his willingness to resort to extreme easing measures in a potentially deflationary downturn, including offering to subjugate monetary policy to fiscal policy if necessary. The MPC may be nominally independent of government, but it tends to be selected to independently decide to do what the government would like it to do anyway.

I would argue that present Bank of England provides a good example of the result of this stealthy jury-rigging. There, it may have even extended to the internal staff below the MPC, with hawkish analysts and advisers being excluded, sidelined or eased out – dovish MPC members may not relish being frequently reminded that some experts consider their monetary policy stance questionable at least. UK inflation has persistently overshot its official target for much of the last three years, but the BoE simply writes the required explanatory letter to the UK finance minister (which is supposed to represent an embarrassment for the central bank, to be avoided if possible), typically blaming "temporary" factors for the overshoot and asserting that inflation will fall back to target in the "medium term", the finance minister replies accepting the BoE explanation, and inflation proceeds above target regardless.

The Fed has also become increasingly institutionally dovish, especially since the financial crisis. To me, Fed statements often seem biased towards arguments that justify easing. Fed officials seem to emphasise different measures of inflation and inflation expectations according to the case they are trying to make. For example, Bernanke used to say he preferred surveys of inflation expectations, on the grounds that the liquidity differences between conventional and inflation-linked bonds made bond market expectations of inflation unreliable. Lately, however, the Fed has preferred bond market expectations of inflation, which have been more supportive of the argument that there is a danger of deflation. Similarly, the Fed is presently emphasising core measures of inflation, despite that fact that its mandate makes no such distinction. Fed officials often raise the example of the Japanese deflationary slump to justify pre-emptive easing, despite the facts that US inflation has never become unequivocally close to being negative, and that deflation in Japan did not become a Fisher debt-deflation spiral.

JP Koning said...

C'mon Rebel, that response should be made into a new blog post ;)

"The MPC may be nominally independent of government, but it tends to be selected to independently decide to do what the government would like it to do anyway."

Great point, and a bit chilling too. My understanding of the appointment process of MPCs is confined to Canada, but I wholeheartedly agree with you.

Here was the process for installing Mark Carney, or at least as I read it. The Bank of Canada governor is selected by the BoC’s 12-member Board of Directors. But these directors are in turn appointed by the PM’s own Minister of Finance for three-year terms. From the time he arrived in office in February 2006 to June 2007 Stephen Harper installed eight of his own directors, all good ol’ conservatives. The rubber stamp in place, Mark Carney was “chosen” by the board in October 2007 to be the next BoC governor. Carney had worked for Harper’s Finance Minister Jim Flaherty prior to his nomination – Flaherty and Harper knew what type of man they were installing inside the BoC.

In response to your point about a lack of any real slap on the wrist for UK inflation targets being overshot, I was going to bring up New Zealand as a healthy counter example. They seem to have encoded into their governing Act a formal process whereby the board can remove the governor for failing to meet targets. But as far as I see it... who really cares... as long as the board is appointed by the minister, they can find reasons to ignore the act and let the governor continue on his target-breaking policy.

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