What Should We Make of the QQE-NIR?
Introduction of the QQE-NIR
The Bank of Japan (BOJ) made a surprise move on January 29 by introducing a Quantitative and Qualitative Monetary Easing with a Negative Interest Rate (referred as QQE-NIR hereafter) with an aim of securing their commitment of achieving an inflation rate of 2 percent.
The QQE part has not changed: It is committed to expand the monetary base by 80 trillion yen per year, and, for that purpose, continues to purchase long-term government bonds, ETFs, and J-REITs accordingly.
But the NIR part is new: It will introduce a three-tier system to the current account balance held by the commercial banks at the BOJ.
The first two tier corresponds to the system that was in place until the announcement of the new one: Average amount of the current account balance held during 2015 (the Basic Balance) will earn a positive 0.1 percent interest. The required reserves under the Reserve Requirement System plus any add-ons that the BOJ will approve in the future (the Macro Add-on Balance) will accrue no interest rate on the balance.
In contrast, what is new is the third tier: Any excess reserves that would be held in excess of the Basic Balance and the Macro Add-on Balance (the Policy-Rate Balance) will be subject to a negative interest rate of 0.1 percent: It means that the banks will now have to pay interest on the current account balance that they ask the BOJ to hold.
The expected impact of the negative interest rate on Tier 3 is to force commercial banks to shift the composition of their assets away from current account balance to new lending to firms and/or to new investment in risky assets. It is anticipated that it will contribute in stimulating business investment and other economic activities in the private sector.
It may be important to note, in this connection, that even when the banks are actually persuaded to lend and invest, it will not lead to a reduction in the current account balance at the BOJ. That is because the monetary base, of which the current account balance commands a large share, is targeted to increase by 80 trillion yen each year. It means that, even though a bank runs down its current account, it will be offset by an increase in current account balance held by others.
Reasons for the introduction
The reasons for the surprise decision by the BOJ can be considered to be the following.
First, the development in the CPI has not been so favorable as the BOJ hoped to see.
After showing steady rise since the start of the Abenomics, reaching 1.6 percent by March 2014, the inflation rate gradually started to weaken because of the weakness in business activity due to the consumption tax rate hike that took place in April 2014, and of the negative impact of the falling oil prices that took place after late 2014.
The most recent forecast produced by the BOJ itself shows that the target of 2 percent will be reached only in the first half of FY2017. Being in such a situation, the BOJ was gradually cornered to introduce additional measures to reinforce their commitment of achieving the 2 percent inflation rate.
Second, the purchase of long-term government bonds by the BOJ has been gradually reaching its limit.
The current commitment of the BOJ is to purchase 80 trillion yen worth of long-term government bonds each year. However, the government in the recent years only issues about 40 trillion yen worth of new government bonds. It means that the BOJ needs to purchase the rest from the existing portfolios held by commercial banks, insurance companies, and others.
Since all of the existing stock of government bonds in their portfolios are not for sale, due to the needs as collateral and others, it was almost certain that the BOJ’s purchase scheme will face the limit in the near future. In fact, the IMF expected that the limit will be reached sometime between 2017 and 2018, and the JCER estimated that the limit will be reached in mid-2017.
It means that the limit may be reached just about the time when the inflation rate is expected to achieve 2 percent. If the achievement of the inflation rate is delayed for some reason, purchasing government bonds will no longer be possible. In view of the risk, therefore, the BOJ had to expand, in some way or the other, monetary policy tools if the inflation target was to be achieved.
Third, the BOJ had to act to the increasing uncertainty that became evident since the beginning of the year.
The stock prices have shown a rapid fall. Appreciation of the yen took place during the stock market turbulence due to the perception that the yen is a safe currency to hold during a period of uncertainty. Since the fiscal policy was not in a position to move as the supplementary budget has just been approved by the Diet, much was expected from the monetary policy.
What can we expect of the QQE-NIR?
If the reasons for the introduction of the QQE-NIR is as such, can we expect that it would live up to the expectations?
First, Japan’s own experience shows that the impact of withdrawing positive interest rate on the current account at the BOJ may not have a large impact.
During the Quantitative Easing Policy period of the 2001-2006, the first unconventional monetary policy introduced by a central bank, the current account balance altogether accrued no interest. It was expected, at that time, that it would provide incentives for the banks to lend or invest. However, empirical evidence shows that it was not the case.
While we never had an experience of introducing a negative interest rate on the current account, the above experience provides a basis for a somewhat pessimistic expectation.
Second, the banks have been reluctant to lend or invest.
Banks prefer to avoid taking risks as much as possible, and would rather invest in riskless assets such as the government bonds than lending to small business. That can be confirmed by observing the composition of their assets.
Third, the firms themselves do not have the incentive to borrow.
The firms are facing a shrinking domestic market. That is a concern especially for the non-tradable sector. In such a circumstance, they are not able to see the need to expand their production capacity. In fact, the decline in net capital stock is already evident in the data provided by the system of national account (SNA): The growth of net capital stock has been on a declining trend since early 1990s, and is currently showing no growth.
In addition, even though they may decide to invest in business plant and equipment, there is no need for the firms, large firms in particular, to borrow from the banks because they now can finance it either by their ample cash holdings or by tapping the capital market.
Possible direction of further monetary easing
The QQE-NIR as well as the QQE depends on the banks as the main transmission channel. Liquidity is provided to the banks and the expectation is that the banks will increase lending or investment in risky assets.
As we have seen, however, there may be only a little that we can expect from the transmission channel via banks. If that is the case, monetary policy would eventually have to find a way to avoid the dampening effect that banks exert on the transmission mechanisms. A possible option for that end is for the monetary policy to expand its perspective by providing liquidity not only to the banks but also directly to the market.
In order to achieve the inflation target, the BOJ may need to expand the QQE further towards that direction.