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Empty Mind after Ten Thousand Reasons

Questioning the framework of monetary policy



  At the December 2022 Monetary Policy Meeting, the BOJ raised the de facto maximum interest rate on 10-year government bonds from 0.25% to 0.5%. Although the upward pressure on government bond interest rates seemed to have subdued due to the expansion of government bond purchase limits and the expansion and extension of common collateral operations, its sustainability is dubious.

 The 10-year government bond rate remains isolated from other market rates, and the original aim of maximizing the effect of the negative interest rate policy has not materialized. The dysfunction of the market has spread to the arbitrage trading of government bond futures and the issuance of corporate bonds.

 The problem with “quantitative and qualitative easing policy with short- and long-term interest rates control” is as the name suggests. It is a policy framework that attempts to control both quantity (monetary base) and price (short- and long-term interest rates) at the same time, but achieving both is difficult. The BOJ promised “maintain positive monetary base growth until the 2% inflation target is stably achieved” when this policy was introduced (September 2016). However, due to the partial abolition of the special program in response to the new COVID-19, the growth of the monetary base has been negative from the previous year for five consecutive months since September 2022. Accountability matters, and it is required to play a role as a financial stability policy.

 Maintaining the nominal long-term rate at a low level amid the continuation of significant inflation around the world, including Japan, is similar to trying to maintain a fixed exchange rate system in the face of fundamental disequilibrium.

 The BOJ is trying to deal with this by widening the fluctuation range of the long-term rate, but considering its exit strategy, it should shorten the interest rate target maturity to 3 years and use it as forward guidance for its negative interest rate policy. However, it should be noted that the Reserve Bank of Australia’s (Central Bank) yield curve control (yield target policy) for 3-year government bond rates ended in failure. The reason for this is that it did not foresee the rapid progress of inflation and did not specify the conditions for ending the policy.

 It is highly uncertain as to what extent high the long-term rate rises at the end of yield curve control. Since the long-term rate depends on the future development of the short-term policy interest rate, there is a view that it should wait until the negative interest rate policy is lifted. On the other hand, the fundamental determinants of the long-term rate are market expectations for medium- to long-term nominal gross domestic product (GDP) growth rates and risk premiums.

  In January, the Cabinet Office presented a 0.5% baseline case and a 3% growth case for future nominal growth rates. The current potential growth rate is around 0.5%. If the market expects the nominal growth rate of 0.5% over the past decade to continue into the future, it is consistent with the long-term rate of 0.5%. However, the market forecast for 10-year interest rates is around 1%, which doesn’t match the two nominal growth rates set by the Cabinet Office.

 In the transition period to a decarbonized society, the ceiling of growth will be lowered due to the limited earth resources as an additional constraint, and the “greenflation” due to decarburization will continue. The central bank cannot control this part. Taking into account greenflation, the price stability target defined by the consumer price index excluding fresh food and energy (BOJ core CPI) is lower than 2%. This point should also be taken into consideration when setting the price stability target as a long-term target.

(English translation of Morning Edition of the Nikkei with 2023/2/17)