Shifting Target in War on Deflation

Bank of Japan decided to shift its target of monetary easing policy from quantity of money in the market to long-term governmental bond rate in the Policy Decision Meeting on Wednesday. Failing to achieve 2% inflation target in two years set in April 2013, BoJ chose alternative way to defeat deflation, which was recognized as the greatest evil in Japanese economy by Shinzo Abe administration. Nobody knows whether new policy of the central bank will work, anyway.

Under the leadership of its governor, Haruhiko Kuroda, BoJ has been delivering various policies, which was called Kuroda Bazookas, to raise commodity price to 2%. Although the bank kept on pouring money into the market, the price did not go up with some elements including negative impact of raising consumption tax rate. From January of this year, the bank introduced negative interest policy, insisting on its monetary easing policy.

While BoJ decided to maintain its interest rate at -0.1% in the Wednesday meeting, negative interest policy had actually been harming Japanese economy. With extremely low interest rate, private banks were suffering from deterioration of their financial balance. Pension system or insurance companies faced difficulty in their management. With low interest of long-term bond, consumers got reluctant to spend money with negative perspectives for their future. Collateral damage seemed bigger than the hope for positive spending.

New target was set to stabilize the rate of 10-year governmental bond at around 0%. The holdings of governmental bond would be increased by about ¥80 trillion a year, while keeping its 2% inflation target. Wall Street Journal criticized its policy change as firing in two directions at once. “Imagine a banana trader who assures growers that he will buy as many or as few bananas as necessary to keep the market price at 50 cents a pound, and simultaneously announces plans to buy 80 tons of banana a year from them. One day, high demand drives the price up to $1 a pound, before the trader hits the 80 ton target. Then what?” described the article.

It is highly unusual for a central bank to set a target on long-term bond rate, because of the difficulty of controlling it. Even though BoJ buys 90% of monthly issued governmental bond, long-term interest rate is affected by economic situation in the future. Kuroda is self-confident that his monetary easing policy could guide long-term bond rate to a low level, and that he can manipulate the market as the bank could do it in short-term rate. Some economists worry that the policy will further be distorting market economy.