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Japan is still a monetary policy pioneer

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Bank of Japan updates

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It’s a bonanza week for central bank announcements: the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England all have meetings (though the ECB’s is not a monetary policy meeting), with central banks of many smaller but still sizeable economies keeping them company.

At the time of writing only the Japanese policy decisions have been announced of the four big central banks mentioned above. They largely keep a steady course. But paying attention to the BoJ is still worthwhile.

For 20 years, the BoJ has in many ways been ahead of the game. It had to figure out how to deal with very low inflation and market interest rates more than a decade before its counterparts. As a result, it wrote much of the rule book, pioneering new policy instruments that have become part of every central banker’s standard toolset. They include quantitative easing (buying government bonds in the market to expand the amount of money in circulation and ease financing conditions), qualitative easing (buying riskier securities linked to stocks and real estate values), and yield curve control (pinning down long-term benchmark interest rates). And while it was not the first central bank to introduce negative interest rates, it was by far the biggest to do so when it did.

What happens in Japan — in its economy and its central bank policy — is, in other words, not a bad indicator of what may soon happen elsewhere.

Earlier this month I conducted a “fireside chat” with the BoJ governor, Haruhiko Kuroda — watch the video below to get a sense of his thinking.


The main innovation from the BoJ this summer is a monetary policy instrument to promote green investment. Now, it’s nothing new that central bankers think they should contribute to our generational challenge of decarbonisation — as Free Lunch readers will know, the BoJ is rather late to the party. But it has chosen an original approach.

With a new dedicated lending facility, the BoJ will reward banks that finance green, decarbonising investments. The form this will take is an allocation of cheap credit tied to the amount of “green” lending a bank extends to companies. That credit will be priced at a zero interest rate, but the real incentive is to allow the bank in question to shift its reserves on deposit with the BoJ from lower-paying to higher-paying categories. As my colleague Robin Harding explained when the scheme was announced, this amounts to a 0.2 per cent per annum subsidy of private banks’ green loans.

Many other central banks have used cheap credit to banks to subsidise particular lending activities — the BoE’s Funding for Lending Scheme and the ECB’s targeted longer-term refinancing operations (TLTROs) are examples of this. Indeed the BoJ already had its own version of this. But it is, to my knowledge, the first such facility (at least from a major central bank) that is set up to subsidise green lending specifically. In Europe, activists have encouraged the ECB to introduce “green TLTROs”, but the BoJ’s Climate Response Financing Operations are a green TLTRO in all but name.

A big shortcoming in the Japanese scheme is that it is up to the banks themselves to classify which of their lending to customers counts as green. That leaves them and the BoJ wide open to charges of “greenwashing”. But in his conversation with me, Kuroda argued the central bank is making a virtue of necessity. There are no universally agreed criteria for green lending at the moment, but he said that rather than waiting, this scheme will demand some disclosures for banks and is flexible enough to be updated with tighter criteria when they become available. It is a clever solution to the question of whether central banks would disrespect “market neutrality” by trying to support decarbonisation, something hotly debated in central banking circles. Perhaps this will be another Japanese innovation eventually spreading to the rest of the world.

Back in traditional monetary policy territory, Japan has long struggled to get inflation anywhere near its formal 2 per cent target. Astonishingly enough, the price pressures in other big economies, due to a quick recovery from the pandemic combined with various supply disruptions and bottlenecks, are not making themselves much felt in Japan. Kuroda pointed out that underlying inflation was picking up, and he expects it to exceed 1 per cent by 2023. But that is still a far cry from what is seen in the US and the UK, in particular, or even the eurozone. Yet Japan is part of the same global economy as they are. So why this difference?

The best answer I can come up with is that inflation expectations really matter, and that it takes a long time to move them. Conditioned by decades of low or no inflation, the Japanese economy does not quickly absorb price pressures from the outside. But Kuroda points to some change: companies are not, like in previous periods, responding to weak demand (this time in the pandemic) by cutting prices.

Kuroda promises that the BoJ will continue or even intensify its measures and cut rates more if inflation does not eventually move up to the target. But in the spring, the bank’s policy review was seen as largely preparing the ground for pulling back aggressive stimulus. It did not, however, and in my view importantly, give up on targeting 10-year interest rates directly, something it is still alone in doing.

There is much to be said for such yield curve control. It allowed the BoJ to achieve the same as quantitative easing without committing to fixed amounts of bond purchases. There seems to be no real harm done to the Japanese government bond market. The policy works. If the recovery solidifies and the time comes for central banks to tighten — even in Japan — the policy may really come into its own. It will eventually allow the BoJ to sidestep the finely balanced decision of how many bonds to sell into the market: it can simply gradually raise its 10-year interest target instead. Once again, a Japanese central bank innovation could become just what the doctor ordered in other economies as well.

Other readables

  • Consider signing up to Road To Recovery, our newsletter bringing you top news and good reads about business and the economy on the way out of the pandemic. For a sample, last Monday’s newsletter explained how that road to recovery could be undermined by the soaring prices for natural gas. On that topic, the FT Editorial Board warns world leaders not to let climate policy fall victim to the energy crisis.

  • On Sunday, Germans will choose who will succeed Angela Merkel as chancellor. UniCredit’s Erik Nielsen has one of most persuasive notes I have seen on what the election could mean for German and European economic policy. He notes that the Greens will have a strong influence in post-election coalition talks despite falling in the polls towards the end of the campaign, and points out an evolution in the fiscal policy debate among politicians and economists. As a result, he expects the election to usher in a big boost in German investment spending.

  • On Merkel herself, Jeremy Cliffe’s long read is unmissable.

  • And how did the German economy change during Merkel’s 16 years as chancellor? Valentina Romei has the numbers.

  • The Norwegian Data Protection Authority has decided not to have a Facebook page because it cannot guarantee that users’ data will be treated as legally required. Its German counterpart has already told government entities to switch off their Facebook pages for the same reason.

Numbers news

* This article has been amended since original publication to clarify that the ECB meeting this week is not a monetary policy meeting

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