Japan's Monetary Policy Changes toward Normalization

But Unlikely to Boost Kishida Administration

By Takuya Nishimura, Senior Fellow, Former Editorial Writer for The Hokkaido Shimbun
The views expressed by the author are his own and are not associated with The Hokkaido Shimbun
You can find his blog, J Update here.
March 24, 2024. Special to Asia Policy Point

The Bank of Japan (BOJ) decided to end its negative interest rate policy and to modify its Yield Curve Control (YCC) program, at the Monetary Policy Meeting (MPM) on March 19. Closely watching the condition of the Japanese economy, in particular the current trend of wage hikes, the Central Bank judged “it came in sight that the price stability target of two percent would be achieved in a sustainable and stable manner.”

However, this is not a declaration of having reversed decades-long deflation. Welcoming the BOJ decision, Prime Minister Fumio Kishida stressed his determination to end the deflation.

In the statement issued after the MPM, the BOJ raised the target for the uncollateralized overnight call rate (otherwise known as the short-term interest rate) from a negative rate to just above zero -- 0 to 0.1 percent. The target rate, which is based on trades in accounts that that private financial institutions hold at the BOJ, was minus 0.1 percent to zero percent before the decision.

The BOJ also decided to discontinue two parts of the YCC program. First, the YCC had included a hard cap of 1.0 percent on Japanese government bonds (JGB). The BOJ removed this cap. Second, as part of the program, the BOJ purchased exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). The bank had started the purchases of these assets in 2010. BOJ has now ceased these purchases.

BOJ has not entirely abandoned the YCC, however; it will continue to purchase long-term Japanese government bonds (JGB) in the same amount as before -- six trillion yen per month. Although the bank recognized in the latest MPM that the negative interest policy and the YCC had fulfilled their roles, it will continue to purchase JGBs in case of a rapid rise in long-term interest rates.

On the reason for this change of policy, in his press conference the BOJ Governor Kazuo Ueda referred to the current tendency to raise wages in the annual wage negotiations of private firms. In the interim report of the Japan Trade Union Confederation, or Rengo, in mid-March, the average ratio of wage increases showed a 5.28 percent rise, exceeding five percent for the first time since 1991.

The mixture of a short- and long-term interest rate policy has been unusual for a Central Bank. The BOJ was the last Central Bank in the world to hold to a negative interest rate policy. Ueda stressed that the Bank would use the short-term interest rate as the BOJ’s primary policy tool once monetary policy is normalized. “It is anticipated that accommodative financial conditions will be maintained for the time being,” said Ueda.

“It is appropriate to maintain accommodative financial conditions from the perspective to assure a positive trend in the economy,” said Kishida about the BOJ decision. He added that he was not thinking about revisions to the joint statement, commonly called the accord, released by the government and the BOJ in 2013. To overcome deflation and achieve sustainable economic growth, the accord set a two percent inflation target. This remains the BOJ’s target.

The accord is the origin of the BOJ’s ultraloose monetary policy. Two months after the accord, the BOJ Governor Haruhiko Kuroda, who was appointed by Prime Minister Shinzo Abe, announced in his first press conference that he would attain the price stability target of two percent within two years. Although the target was not achieved in two years, the BOJ maintained this goal. The Bank introduced the negative interest rate policy and the YCC in 2016, pouring a large amount of money into the market.

The BOJ policy was closely connected to the economic policy of the Abe administration, called Abenomics. “The Government and the Bank of Japan will strengthen their policy coordination and work together,” says the accord. Bold monetary policy was one of the three pillars of Abenomics, together with an agile fiscal policy and a growth strategy for the private sector. Although Abenomics brought about the depreciation of the Japanese yen, encouraging exporters in Japan, it did not result in an increase in workers’ real wages, an index which takes price hikes in account.

It was after Abe retired as the prime minister that consumer prices showed an apparent rise, mainly caused by foreign events such as Russia’s invasion of Ukraine. Repeatedly encouraged by the government, private firms began to increase workers’ wages. The stock market rallied with foreign investments attracted by the cheap yen and by the instability of the Chinese economy. The BOJ decided that a positive cycle of price hikes and wage hikes can be expected, even though the current condition of the Japanese economy does not necessarily reflect its power for growth.

The BOJ’s large-scale monetary easing policy has been criticized for distorting the market. The BOJ holds over half of all JGBs in the market. If the BOJ were to remove its JGBs from the balance sheet along with other changes to the YCC policy, it would have a great impact on the market. If the interest rate on JGB goes up, the government, whose budget is highly dependent on JGBs, has to pay it.

The interest rates on housing loans are expected to be rise, possibly shrinking consumption. The people in Japan need to live in “the world with interest rates.”

Higher interest rates also may affect small and medium-sized enterprises (SMEs) when they borrow money from bank. Seventy percent of all firms in Japan are categorized in SMEs, and their profitability is lower than large firms. Whether SMEs can add their cost increases from higher interest rates to consumer prices may be the key to achieving a sustainable price rise.

Although the BOJ does not believe that the price stability target has been achieved, Prime Minister Kishida is searching for the right time to declare that the era of deflation has ended. He expects the declaration to boost his administration’s low approval ratings. However, BOJ Governor Ueda did not indicate when Japan would exit from deflation or when the Bank would further raise the target interest rate. It is thus uncertain whether the condition of the Japanese economy will help the Kishida administration.