3 years into the Bank of Japan’s Unprecedented Monetary Easing

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The monetary easing by the Bank of Japan has started its 4th year. What remains unclear is whether the central bank’s target of 2% inflation will be achieved

The bank initial sought to achieve the goal in 2 years – this has now become “by the first half of 2017.” But the latest survey by the bank shows business sentiment has fallen back to levels right after the monetary stimulus was launched.

As a result, there is speculation that the BOJ will take additional easing steps - either expanding its asset purchases to pump more money into the economy or increasing the negative interest rate policy that it began in January 2016. But the performance of the past 3 years points to the limitations of relying on central bank actions in fighting deflation.

Tapped by Prime Minister Shinzo Abe to take charge of a key component of his “three arrows” to pull Japan out of deflation, Kuroda launched the massive asset purchase program in April 2013 right after his inauguration as BOJ chief. With its annual purchase of ¥50 trillion in government bonds (later expanded to ¥80 trillion) the central bank sought to double the nation’s monetary base within two years. Kuroda stressed that the BOJ, by demonstrating its commitment to busting deflation, was aiming to raise inflationary expectations of the public and businesses, thereby encouraging them to spend and invest more.

The BOJ’s monetary stimulus had the biggest impact among the Abenomics policies, which included aggressive government spending and regulatory reforms (although this component never got off the ground) to drive economic growth. The massive easing caused the yen to fall sharply against the dollar, pushing up the profits of exporters and triggering a surge in share prices. The increase in the cost of imports appeared to put inflation on course to meet the target set by the central bank.

But the inflationary trend slowed following the consumption tax hike in April 2014, when the consumer price index (not including perishables and the effects of the tax hike) registered a 1.5% year-on-year increase. Personal consumption slumped as prices rose faster than wages, while inflation has fallen mostly flat in recent months with the decline in global crude oil prices.

The BOJ’s asset purchases have indeed boosted Japan’s monetary base — which hit a record ¥375 trillion at the end of March, an increase of 27% from a year ago. The monetary base rose ¥240 trillion in 3 years from the ¥134 trillion in March 2013. But the biggest component of the monetary base remains financial institutions’ current account deposits in the central bank which rose 37% over the past year to ¥275 trillion as the BOJ kept buying government bonds from the institutions. The negative interest rate policy introduced by Kuroda in January is reportedly meant to prod banks to lend more and drive down interest rates, but what impact the policy will have on consumer and business sentiments remains to be seen.

The falling business sentiment, though it is still in positive, is blamed on growing uncertainties over the global economy, in particular the slowdown in China and the sudden spike in the yen’s value this year — which in turn exposes the vulnerability of Japan’s economy to fluctuations in overseas demand and currency exchange rates. The inflationary expectations of firms polled in the BOJ survey are also moving down below the BOJ’s 2% target.

The BOJ’s 3 years of maneuvers under Kuroda underline just how far monetary policies alone can go in turning the economy around. The effects of Abe’s “second arrow” of fiscal stimulus, which has its limits under the nation’s tight fiscal conditions, have been waning, while his promised structural reforms have yet to make a visible impact on the economy. It may be tempting to lay the blame for Japan’s fragile growth elsewhere. But the central bank itself should also stop to think whether its logic behind the monetary stimulus program still holds 3 years on.