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Financial Research Monetary policy （No. 45）
Estimating the impact of the Fed’s monetary policy normalization on long-term U.S. interest rates and the beggar-thyself policy effect on Japan if the BOJ maintains easing policy
- We estimate the extent to which the Fed’s QT will push U.S. long-term interest rates higher in the future, following Li and Wei (2013). If QT proceeds as market participants expect, the long-term U.S. interest rate will reach 3% in November 2023 and 3.6% in December 2025. The faster pace of QT could push the U.S. long-term interest rate as high as 4.5% in December 2025. This is the highest “level” since October 2007, before the start of quantitative easing (QE1).
- Since there is a strong positive correlation between Japanese and U.S. long-term interest rates, a rise in the latter will likely to result in a rise in Japanese Government Bond (JGB) yields. This means that the pace of the Fed’s QT will determine Japan’s long-term interest rates. If the Fed’s QT goes as market participants expect, long-term JGB yields will reach 0.25%, the upper limit set by the BOJ, and rise to 0.35% by December 2023. If the BOJ then attempts to maintain the JGB yields at 0.25% through a fixed-rate purchase operation, a total of JPY 35.7 trillion in additional purchases of long-term JGBs will be required by the end of 2023, or JPY 52.8 trillion if the pace of QT is accelerated.
- The monetary base in Japan is expected to gradually decline as the Bank of Japan’s Special Program to Support Financing in Response to the Novel Coronavirus (the Special Program) will mainly conclude at the end of March 2022. Even if the BOJ purchases JGBs through fixed-rate purchase operations to limit the increase in long-term JGB yields caused by the Fed’s QT, Japan’s monetary base is expected to decline this summer. The BOJ needs to examine the decline in the monetary base and account for any inconsistency in its commitment to continue its monetary base expansion policy until the year-on-year rate of increase in the CPI exceeds the price stability target of 2 percent and steadily stays above the target.
- While the Fed is beginning to normalize monetary policy, the BOJ is expected to maintain monetary easing. The diametrically opposed monetary policy directions of the BOJ and the Fed could lead to “relative monetary easing” in Japan, which could increase the pressure for a weaker yen. The combination of higher oil prices and a weaker yen risks turning the BOJ’s quantitative and qualitative monetary easing (QQE) into a beggar-thyself policy, further reducing real consumption per capita.