What have been the effects of three years of monetary easing in Japan? Less than nothing, writes Kojima Akira.
This article first appeared in the July/August 2019 print edition of the Japan Journal.
In February 2019, a full three years had passed since the Bank of Japan introduced its negative interest rate policy. The BOJ aimed to raise the consumer price index to 2% per year based on this extraordinary policy of monetary easing. However, the year-on-year rate of increase in the consumer price index came to a halt at 0.1% in 2016, 0.5% in 2017, and 1.0% in 2018. As of April 2019, the price level had risen by a mere 1.8% when compared to 2015.
Under negative interest rate policy, financial institutions in the private sector are forced to pay for current accounts (reserve deposits) held in the BOJ. It is a commission charged on funds that lie dormant in BOJ accounts instead of being put to use by the banks. The BOJ expected that the charges would motivate financial institutions to lend to corporations and individuals. However, banks have by no means increased their lending. The BOJ has continued to supply huge amounts of capital in the form of buying national debt held by financial institutions, but these funds have simply turned into reserve deposits accumulating in the BOJ rather than entering the lending market. Funds are splashing around the money markets, which are the markets for financial institutions (interbank markets), but the funds are still not entering the real economy, i.e., economic activity and consumption activity. The extraordinary policy of monetary easing has barely had any effect.
On the contrary, it has led to situation where the side effects of the negative interest rate policy include suppressing business at financial institutions, reducing the return of interest from the financial assets of individuals, and oppressing pension fund investment yields to the point where the nation is concerned about the future of the pension system.
In the past, the idea that monetary easing would revitalize economic and consumption activity, and that prices would rise as the economy heats up has been considered the common sense approach. Today, this approach has fallen flat on its face. In a brilliant analysis of the reasons, Richard C. Koo at the Nomura Research Institute has long developed the theory of balance sheet recession. According to Koo, corporations were struggling with excessive debt after the collapse of the bubble economy in 1991. Financial institutions, which were hard pressed to dispose of bad loans, restricted lending and even withdrew credit. Therefore, a structural conversion from profit maximization to debt minimization became the goal of corporate activity. Even if a corporation made a profit, they did not actively invest but serviced their debts instead. Corporations create profit to service debt by reducing and cutting the cost of labor, not by creating new business, developing goods or services, or opening up new markets. As a result, household incomes do not increase and the consumption activities of individuals stagnate.
Koo has pointed out that since the Great Depression in the 1930s, Japan has become the first country among the developed nations where the private sector minimizes debt because of the balance sheet issue. Further complicating the degree of deteriorating balance sheets, Koo also draws attention to the fact that since the collapse of the bubble economy, prices in the commercial districts of Japan’s major cities have fallen by as much as 87% since their peak causing losses on the balance sheet that are higher than those of the United States during the Great Depression.
There has not been a single crack in Koo’s argument for nearly twenty years now. His new book, The Other Half of Macroeconomics and the Fate of Globalization (Wiley 2018), is the tour de force culmination of his theory on balance sheet recession.
According to the theory of balance sheet recession, the current extraordinary monetary easing policy at the BOJ will bring next to no results. On the contrary, the policy will have major side effects.
Due to the globalization of the world economy, including the rapid rise to prominence of China and other emerging nations, Koo also argues that developed countries share a new reality where (1) conventional systems and management no longer apply, putting the developed countries under pressure, and (2) the economies of the developed countries have become deflation-biased economies that put downward pressure on prices.
On the flip side of this argument, the newly prominent Modern Monetary Theory (MMT) has created a stir in the United States. MMT advocates argue that governments issuing locally denominated currency and government bonds do not need to consider budget deficits, outstanding debt, or finance reform. Since governments can finance their debt by printing money, they are not faced with fiscal constraints.
Some advocates of MMT claim that Japan, where bond yields have not rocketed but stopped at zero or negative despite a government debt in excess of 200% of GDP, provides proof that MMT is correct. MMT has been welcomed with open arms by some Japanese politicians who have continued with pork barrel practices in public financing and made no serious attempt at fiscal reform.
There is a danger that Japan will be seduced by MMT because the harsh reality is that Japan is faced with a decrease in the total population due to falling birthrates and a population that is aging more rapidly than anywhere else. What is more, corporations are too risk averse and responses to the digitization of the economy, society, and government (administration) are lagging behind. There is a pressing need to develop current economic policy, which has been overly reliant on monetary easing at the BOJ, from the broader perspective of reforms to the education system and corporate management as well as institutional reform including fiscal policy and regulatory reform.
KOJIMA Akira is a member of the Board of Trustees and professor of the National Graduate Institute for Policy Studies.