Analysis: Fed’s accommodative approach to inflation complicates BOJ debt reduction plans

A man walks past the Bank of Japan building in Tokyo, Japan on January 15, 2018. REUTERS / Kim Kyung-Hoon

The US Federal Reserve’s recent pledge to keep interest rates low despite rampant inflation has created new headaches for the Bank of Japan, which is quietly trying to wean the economy off its massive stimulus measures.

The Fed reframed its targets in August amid the pandemic recovery, allowing consumer prices to rise faster than what would have been tolerated by the US central bank in previous cycles.

While the BOJ, a pioneer of quantitative easing, has maintained extremely accommodating parameters for decades, its operations are still guided to a large extent by how Fed policy affects global interest rates.

Fearing that an accommodating Fed would jeopardize Japan’s efforts to keep market rates near zero, the BOJ, at its March policy meeting, sought to honor the US commitment to do so. .

For BOJ policymakers, this meant breathing new life into its elusive 2% inflation target, making it more difficult to pull back from past commitments to maintain a massive stimulus.

The move highlights the enormous influence of Fed decisions on BOJ communication, as Japanese policymakers feel the need to stay in tune with global monetary policy trends shaped by the country’s most powerful central bank. world, according to sources close to his thought.

“This was something the BOJ had to clear up after what the Fed did,” one of the sources said, an opinion echoed by another source.

“The BOJ’s commitment has become more binding and more difficult to eliminate,” said a second source. The sources spoke on condition of anonymity due to the sensitivity of the matter.


This accommodating signage comes at a tricky time.

While the BOJ must maintain sufficient support to help the economy weather the pandemic, it is also under pressure to get rid of an unpopular negative interest rate policy that has hurt financial institutions‘ profits.

In response to criticism, its massive purchases distort market prices, the BOJ has also “stealthily reduced” its purchases of government bonds and risky assets.

But the Fed’s focus on keeping interest rates close to zero, and the potential tolerance of above-target inflation for years, shatters the BOJ’s hopes of gradually abandoning its commitment to keep pumping money until inflation “stably exceeds” 2%.

By insisting on a commitment identical to that of the Fed, the BOJ may have a harder time slowing money printing even as the economy emerges from the pandemic, suggesting it will be far behind its counterparts in ending the policies of crisis.


The Fed’s new average inflation target, unveiled in August, would see US policymakers tolerate inflation above 2% for years before raising current interest rates close to zero.

The BOJ has put in place a similar but more flexible and mainly symbolic commitment since 2016, in which it commits to continue to increase the amount of liquidity flowing in the economy until inflation stably exceeds the 2%.

Unlike the Fed, the BOJ does not tie the commitment to interest rates. To avoid a binding future policy, the language remains vague, without reference to the pace of asset purchases or the length of time inflation must exceed the target.

This flexibility had allowed the BOJ to distance itself from the target amid growing doubts about its ability to be achieved.

But the Fed’s explicit shift to an average inflation target has now forced the BOJ to give more weight to its own commitment, a setback for the BOJ’s efforts to reverse Governor Haruhiko Kuroda’s “bazooka” stimulus that had failed to trigger inflation.

A month after the Fed’s decision in August, Kuroda said the BOJ’s commitment was in line with the Fed’s thinking on inflation targeting, suggesting that the BOJ’s commitment already incorporated key elements. of the Fed’s new strategy.

Consolidating the alignment, the BOJ this week released a detailed analysis on how imitating the Fed’s strategy would help meet its price target faster.

The analysis estimated that compensating for about two to five years of past low inflation might be more effective, suggesting that Japan will not see an exit from super-easy politics for years, even after inflation. has recovered.

This would come as little surprise to market participants who already expect the policy to remain ultra-flexible for years to come.

But it could also force the BOJ to maintain a commitment that many analysts see as having little effect on changing public perceptions of pricing.

“What has become clear is that it is impossible to control something like inflation expectations, which are difficult to measure,” said Miyako Suda, an academic who served on the board of directors of the BOJ for a decade until 2011.

“The BOJ must offer a more candid assessment of why its massive stimulus package has not worked out as expected.”

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