The Macro Report | October 2016

Japan on the helipad

The Bank of Japan’s “comprehensive assessment” of policy has led it to clear a path toward potentially radical fiscal change, including the government’s use of “helicopter money.”

Our current Nowcast for Japan has been improving quite steadily in recent months. While there is a lot of month-to-month volatility in the data flow, and it is hard to reconcile often contradictory releases, the Nowcast methodology allows us to include a wide variety of data points and reveal the underlying story. That story is one of steady improvement, and it is now much easier to agree with the BoJ’s assessment that the economy is on a trajectory of moderate recovery.

The real story, however, continues to be inflation, which looks to be dropping further. It is because of this that the BoJ undertook its “comprehensive assessment” of monetary policy, which was behind the important announcements of September 21, 2016. Because Japan is at the leading edge of the G7’s struggles with post-financial crisis macro policy, it is worth spending a little time on what the BoJ did.

Japan’s economy has continued its moderate recovery trend.Bank of Japan, September 21, 2016

Reading Japan’s “comprehensive assessment”

On the day of the meeting itself, the yen rallied quite sharply and almost broke through the psychologically important level of 100 — a reaction to the market’s expectations of further expansion in Japan’s easing program. Our own expectation was that there would be some expansion of the program to include bonds issued by a variety of public sector institutions. Instead, the BoJ adopted what it calls “Quantitative and Qualitative Monetary Easing [QQE] with Yield Curve Control” in a new attempt to overshoot the inflation target and push inflation expectations decisively upward.

The “yield curve control” piece of this commits the BoJ to keeping the 10-year JGB yield at “more or less its current level, around zero percent.” This means abandoning its quantitative JGB purchase targets, since it’s hard to know what level of purchases will be necessary to achieve its new objective. The market, however, saw this as a possible end to Japan’s easing measures, and thus perhaps even a tightening of policy.

We think this is the wrong way to interpret Japan’s move. Instead, we see this as creating the possibility of a substantial policy easing. In the first place, the BoJ has committed to continuing to increase the monetary base. Indeed, it expects its balance sheet to exceed 100% of GDP in one year’s time. Secondly, committing to holding 10-year JGB yields around zero is an open door to fiscal relaxation. Recall that back in January 2013, the BoJ and the Japanese government released a joint statement effectively pledging to coordinate efforts to overcome deflation. This new policy allows the government to expand its spending with no impact on JGB markets.

Will Japan use the helicopter?

There is every reason to believe this form of quantitative easing would be more effective if the government took up the invitation the BoJ has extended. Until now, QQE has consisted of buying government bonds from the financial sector. The financial sector has taken this money and spent it on other financial assets, boosting asset markets but not doing a lot for the economy as a whole. Higher asset prices do affect the real economy by lowering the cost of capital to the corporate sector and boosting wealth effects on household spending, but these effects have not been particularly large. The most effective form of easing would be helicopter money — directly injecting money into the economy via households. (The central bank could just give every household a specific sum of money and be confident that a lot of this money would be spent. Some would go to paying down debt, but accelerating the pace of deleveraging would have the effect of bringing a recovery forward.)

Legal, institutional, and political obstacles stand in the way of genuine helicopter money. But providing central bank financing for government spending would generate spending in the economy, even if the government activity being financed was, in some sense, wasteful. Indeed, Keynes pointed out a long time ago that people could be employed to dig holes and fill them in again; after all, they would spend their wages. Direct central bank financing of the government is illegal in many countries, but the BoJ’s announcements achieve the same effect without directly funding the government.

For this reason, we see the BoJ’s new policy as opening up the possibility of a significantly easier policy stance, if only the government walks through the door that the BoJ has opened.

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