09/20/2016
Back in January, the Bank of Japan (BOJ) adopted a policy of negative interest on excess reserves. As with similar moves by its European counterparts, the new rate regime was designed to jumpstart growth and push inflation higher, by encouraging bank lending, business and consumer borrowing, and by weakening the currency.

In 2015 the Japanese economy grew at a rate of 0.7 percent. And in the first quarter of this year growth improved to an annualized rate of 2.1 percent. Unfortunately for the BOJ, economic activity has since failed to match that performance. Growth in the second quarter slipped to an annualized rate of 0.7 percent. The National Consumer Price Index, which ended last year at 0.2 percent, has since fallen to -0.4 percent in July. And the yen, which stood at an exchange rate to the dollar of 119 just prior to the BOJ’s January move has strengthened to a current level of 102, frustrating any hope of a jolt to exports.

At the end of July, BOJ Chairman Kuroda announced that the central bank would conduct a comprehensive assessment of its monetary policy for discussion at its September meeting. The announcement gave rise to speculation that the bank was considering a range of even more aggressive policy initiatives, including so-called “helicopter money,” in which money is simply printed to finance more expansive government spending.

However, it also gave rise to speculation that the bank had been chastened by the ineffectiveness of its negative interest rate experiment and was beginning to recognize the limitations of monetary policy and was considering a possible step back from increasingly aggressive stimulus. This interpretation caught the attention of markets worldwide. This fear of diminishing central bank support was subsequently reinforced in September, when the European Central Bank chose to leave its policy unchanged, despite the approaching need to enact some adjustments if it intended to continue its own bond buying program.

The Fed’s Hawkish Tone is also in Question

Meanwhile, the Federal Reserve’s own more hawkish rhetoric was being blunted by evidence that the U.S. economy had slowed in August, making an interest rate hike in September less likely. Collectively, the impression was growing that central bank policy was not only diminishing in its effectiveness, but was, in fact, harmful to the private sector especially as a tax on banks and savers alike.

Which brings us to this week ... Both the BOJ and the Fed meet, with the BOJ meeting being arguably far more important. The Fed has the luxury of considering whether to raise rates, although it is probably unlikely to do so. If it does, no doubt markets will react, at least in the short run. But this is not a decision that cuts to the core of central bank effectiveness. It is not a decision that addresses the possible limitations of monetary policy.

Has the Bank of Japan Reached its Limit?

For the Bank of Japan, however, these questions are staring them, and investors, in the face. If it admits to having reached some degree of limitation to its policy impact, market reaction could be severe. The prospect of a world in which markets are less reliant on central bank largesse and increasingly reliant on economic fundamentals and the elusive promise of fiscal stimulus and structural reform is worrying indeed. For this reason, don’t expect the BOJ to pursue this course of (in) action when their meeting concludes on Wednesday. There is another reason.

Despite mixed evidence and a healthy dose of pushback by the private sector, central bankers remain confident that their stimulus measures are the right policies. Yes, there is debate, and there is concern that asset bubbles and general pricing anomalies are occurring, but there remains a fundamental belief that more, not less stimulus is the answer in a world of slow growth. For these reasons, expect the BOJ to remain all in, for better or for worse.

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