Bank of Japan’s “tightening”

Japan’s economic activity and prices have been moderately firmed for over a year now, leading to conclude the BoJ that “implementing a large-scale policy to overcome deflation” was no longer warranted. However, given that the inflation target has been only achieved half-way so far, risks of missing the target remain. Moreover, owing to the high debt burden, the government continues to need low interest rates. Therefore, speculation about a monetary tightening is unfounded.

On November 5, 2018, Governor of the Bank of Japan Haruhiko Kuroda delivered an overall positive assessment of the Japanese economy. “[W]ith a virtuous cycle from income to spending being maintained in both the corporate and household sectors (…) the duration of the current economic recovery phase (…) is likely to have reached 69 consecutive months this August”, approaching the longest post-war recovery phase of 73 months.¹

Based on this, it is just right for the BoJ not to persist on the extremely loose monetary policy implemented previously to fight deflation. However, interpreting Kuroda’s latest comments as hinting “at monetary tightening”² is unfounded.

First, headline inflation has risen to around one percent – which is only about half the target set by the BoJ – and core inflation (excluding the volatile components, fresh food and energy) has remained weak at 0.36 percent on average this year and 0.13 percent in 2017.

Second, inflation developments towards the BoJ’s goal are conditional on maintaining a high degree of capacity overutilization and on the absence of other downside risks. Among the latter, the consumption tax hike scheduled for October next year as well as various uncertainties originating in overseas economies are likely to dampen inflation in the future.

Third, a decisive monetary tightening would create difficulties for paying interest on the accumulated pile of public debt of 238 percent of GDP. The BoJ has come under fiscal dominance.

Against this background, it seems rather unlikely that the BoJ could even approximately follow the interest rate increases currently implemented by the US Federal Reserve. However, policy measures could include a further relaxation of the BoJ’s yield curve control. This would allow more flexibility in the formation of long-term yields and thus counter the negative side effects of too rigid government bond yields as pointed out by the market participants. But this would by no means imply a monetary policy tightening. In the words of Haruhiko Kuroda “the Bank will persistently continue with powerful monetary easing”.³

¹ Haruhiko Kuroda „Japan’s Economy and Monetary Policy“, speech at a meeting with business leaders in Nagoya, November 5, 2018.

² See „BoJ governor Kuroda hints at monetary tightening“, Financial Times on November 5, 2018, for the latest evidence of this view spreading among commentators.

³ Haruhiko Kuroda „Japan’s Economy and Monetary Policy“, speech at a meeting with business leaders in Nagoya, November 5, 2018.