BOJ Yield Curve Control and the Japanese Economy

Economy Politics

In its first meaningful policy shift since Ueda Kazuo took over as governor, the Bank of Japan in July this year announced a new, more flexible approach to yield curve control. The author, an economic policy official in the Abe Shinzō administration, analyzes the policy landscape from the days of Abenomics to the present.

The BOJ Eases Yield Curve Control

At its Policy Board meeting on July 28, the Bank of Japan decided to maintain its yield curve control policy while relaxing its implementation. It will now consider the 0.5% upper limit for the long-term interest rate as a reference, rather than a hard boundary, instead viewing 1% as the effective upper limit.

BOJ Governor Ueda Kazuo explained the purpose of the decision as increasing the sustainability of monetary easing. The current measure follows the December 2022 announcement that the bank would raise the upper range of the long-term interest rate from 0.25% to around 0.5% in order to improve market functionality. It is a hedge against the future risk of market turmoil caused by heightened upside pressure on the interest rate. Rates will naturally rise when Japan’s deflationary economy moves toward normalization, and forcefully restraining this rise will cause turmoil; Governor Ueda appears to be acting now to avoid such a situation.

Ueda stated that while the likelihood of the long-term rate approaching the effective upper limit of 1% is low, the BOJ will intervene flexibly against baseless speculative fluctuations through market operations. He also noted that there is much uncertainty about the outlook for prices, that there is still considerable distance to travel before the negative interest rate can be reversed, and that the movement of interest rates will basically be left to the market to increase the probability of reaching the inflation target. When asked about ending yield curve control in the near future, Governor Ueda said that he will consider an appropriate response at that time.

Such statements by the bank’s head can be viewed as a clear demonstration of his resolve to support Japan’s economy by preventing turmoil in the process of reversing the negative interest rate. With regard to the present, monetary easing must be firmly maintained in view of the current state of Japan’s economy to ensure market confidence. With regard to the future, the BOJ will align with the global trend toward reversing such emergency responses as zero interest rates and nontraditional monetary policies. Governor Ueda’s responses are thus appropriate.

Should the BOJ not align with the monetary approaches in the world’s other financial markets, policy differences could accelerate the speculative weakening of the yen and the ascent of prices, which would have a negative impact on Japan’s economy. This is the lesson to be drawn from the time when Abenomics was formulated.

The Impact of Abenomics and the 2008 Financial Crisis

Abenomics was known for its three policy arrows, the first of which was bold monetary policies—the significance of which was an alignment of the BOJ’s policies particular to Japan with global approaches. Following the 2008 financial crisis, Federal Reserve Chairman Ben Bernanke implemented nontraditional monetary policies (bold quantitative easing) out of concern that doing nothing would risk a once-in-a-century depression. This was Quantitative Easing 1, which was soon followed by QE2 and QE3. The European Central Bank, which was also greatly affected by the financial crisis, adopted similar monetary policies.

The BOJ, however, did not implement similar policies, in part because Japanese financial institutions were less affected by the crisis. As the Federal Reserve announced monetary policies like QE1 and QE2, the yen appreciated far above its actual strength. This served to exacerbate deflationary tendencies in Japan and brought about a severe hollowing out of domestic industries. While a declining birthrate would normally result in labor shortages, the ratio of active job openings to active applicants continued to hover around 0.5 as deflation worsened, and it became increasingly difficult for young people to find employment. The existence of unscrupulous companies exploiting this situation became a social problem, and the suicide rate rose among the young.

A tight job market causes concern for students at a recruitment fair for prospective 2010 graduates on January 11, 2009, at Tokyo Big Sight. (© Jiji)
A tight job market causes concern for students at a recruitment fair for prospective 2010 graduates on January 11, 2009, at Tokyo Big Sight. (© Jiji)

Given these circumstances, the Cabinet Office pressed the BOJ on its quantitative easing stance. However, with most economists supporting its independent monetary policies, the BOJ declined to alter them. The widely shared view was that QE would only result in the accumulation of funds above the legally required reserve in the current account deposits of private financial institutions at the BOJ, and would therefore not have much of an effect on the broader economy. Others, though, argued that the policy effect would be excessive and would lead to hyperinflation, which might not be immediate but could suddenly occur at some future point. Another argument held that, in view of the balance of funds in the current account deposits at the BOJ, buying more than ¥10 trillion in Japanese government bonds was an incalculable risk. Such a move would damage the BOJ’s balance sheet and would invite the sharp depreciation of the yen.

All these arguments—which may reveal a tendency among economists in Japan to focus only on risks—have largely been forgotten. While they had many proponents at the time, once Japan found itself confronted with the reality of a struggling economy, it was the bold monetary policies of Abenomics that took the lead, asserting that Japan should align with its global counterparts to reinvigorate its economy.

Close Dialog with Markets and Diligent Management

Currently, many central banks are engaged in exit strategies to unwind nontraditional monetary policies. This is a natural development in view of economies recovering from the effects of the COVID-19 pandemic and of the new reality of inflation ensuing from Russia’s war on Ukraine. With regard to Japan’s economy, however, the recovery still has further to go, and it is too early to implement exit strategies.

Even so, as financial markets become more global, a lesson Japan should draw from the aftermath of the 2008 financial crisis is that maintaining distinctive monetary policies over the long term comes with risk. The Federal Reserve’s exit strategy of monetary tightening, for example, is seen by Japanese observers as something that would only threaten a recession if implemented here. The Fed’s tightening, however, is aiming for medium- to long-term economic growth. In Keynesian economics, recessions call for vigorous fiscal and monetary policies, while overheated economies need the tightening of policies. This is naturally the basis for exit strategies. During Japan’s high-growth period, the BOJ tightened monetary policy as needed, which contributed to the long-term growth of its economy.

The BOJ’s latest policy decision has been based on the appearance of green shoots of change in the economy, even though its recovery is still ongoing. Wage increase rates in 2023 were the highest seen in 30 years. People are returning to public spaces in the wake of the pandemic, and consumption is firm. The capital spending plans of companies indicate considerable increases ahead. It is highly probable that Japan’s economy has entered a phase where wages and corporate profits increase in a virtuous circle, a realization of the growth strategies that constituted the third policy arrow of Abenomics.

Governor Ueda has stated on numerous occasions that it will be important to carefully foster the “green shoots” of healthy growth, likely in recognition of the economic developments described above. However, given how long it has stagnated, there are still many uncertainties about whether the economy will really be able to put its low growth period behind. To ensure that the positive signs of change take root, the BOJ will need to diligently manage monetary policy while dialoguing with market participants with due care.

Finally, while some observers are concerned about the valuation losses of Japanese government bonds held by the BOJ when monetary policy is normalized and interest rates rise, such concerns are not warranted. This is because such valuation losses are valuation gains for the national government. In Britain, the national government covers the valuation losses of the central bank. When the BOJ purchases JGBs from private banks, it assumes their risk of holding the instruments. This can be viewed as the BOJ converting fixed-rate bonds into variable-rate ones. Should interest rates start to rise, the BOJ will begin paying interest on the funds above the reserve ratio in the current account deposits it holds. While this will reduce the bank’s payments to the national treasury, since the national government will see valuation gains, something will surely be left for the treasury.

(Originally published in Japanese. Banner photo: Bank of Japan Governor Ueda Kazuo holding a press conference after the meeting of the BOJ Policy Board on July 28, 2023, at the Bank of Japan Head Office in Tokyo. © Jiji.)

Bank of Japan finance economy policy interest rates