Japan’s Latest Bold—and Desperate—Experiment in Monetary Policy

After years of trying to spark economic growth by bringing down both short-term and long-term interest rates, the Bank of Japan in recent weeks has been moving to lift yields on government bonds, particularly the super-long-dated ones. In normal times, such a maneuver might be construed as monetary tightening. But BOJ Governor Haruhiko Kuroda has continually stressed that the bank is very much in easing mode. He said last month that the bank “will not hesitate to add stimulus” if needed, and a number of forecasters expect that he and fellow board members will cut the bank’s short-term policy rate—now at negative 0.1%—on Oct. 31.

Kuroda lately has warned that ultralow yields on super-long-term bonds—say, 20-years and up—could be bad for the economy. “It will have a negative impact on consumer sentiment,” he said on Sept. 19. Low yields are psychologically damaging, in a sense, since they reinforce the expectation that economic growth will remain sluggish over the long term, incentivizing Japanese households to save rather than spend. The paltry returns represent a very real threat to Japan’s population of pensioners, which numbered 40 million at last count and is headed inexorably higher. (It is estimated that more than 26 million rely on pensions for 80% or more of their income).

Following those comments, Bank of Japan officials have been trimming back their bond purchases, by the count at Bloomberg Economics, to an annual pace of 5 trillion yen ($47 billion), compared with a previous target of 80 trillion yen. In its latest monthly plan, the BOJ also signaled it might even stop buying bonds with maturities surpassing 25 years.

“They want to have their cake and eat it, too,” says Paul Sheard, a senior fellow at Harvard University’s Kennedy School who worked as an economist in Japan over a three-decade span. In other words, the BOJ wants, on one hand, to boost the economy by depressing short and medium-term rates while, on the other, it wants yields at the very long end to reflect the success it envisions in generating growth and inflation.

To convince markets and the public that it’s committed to easing for the long haul, the BOJ has pledged to keep expanding its balance sheet, which it has done via bond purchases. So if it stops buying some bonds to drive up yields—as prices and yields move inversely—then it must buy more of others. “The problem is, it’s kind of like whack-a-mole,” where the central bank then needs to keep changing its operations to address problems with excessively low yields at differing maturities, Sheard says.

They may yet try to do just that, though.

“Lowering short-term rates while lifting up longer ones will be very challenging,” says Masaaki Kanno, who worked at the BOJ from the 1970s to the 1990s and is now an economist at Sony Financial Holdings Inc. “Obviously the BOJ has to care about pension funds and life insurance companies,” Kanno says, which are hurt if there are negligible interest payments on long-dated bonds. “Japan is aging rapidly, and it’s becoming a big part of the economy.”

The BOJ’s latest moves came after 20-year bond yields slumped to just 0.02% in early September. Since Kuroda started sounding the alarm and officials rejiggered their bond purchases, they climbed to 0.20% by Oct. 10. While it’s hard to gauge the impact to date, Kanno says the central bank could take more forceful action.

What makes these maneuvers tougher is that the BOJ has already bought more than 43% of the entire Japanese government bond market. (In the U.S. the Federal Reserve has about 13%.) In the process, it’s expanded its balance sheet beyond 100% of gross domestic product—much more than the levels of its American and European counterparts at 18% and 39%, respectively.

“Japanese financial institutions were kind of squeezed out” of the domestic bond market, says Tadashi Kikugawa, a veteran bond trader who now works at Nomura Holdings Inc. on investment products for asset managers. “They are happy to come back” any time yields rise.

At the end of the day, the only assured way to boost super-long yields would be to raise the short-term policy rate, Kikugawa says, but that would also risk boosting the yen. A stronger currency is a double whammy for Japan, as it dampens demand for the country’s exports, which account for 17% of gross domestic product, and also weighs down the share price of Japanese blue chips that derive a big chunk of their revenue from sales abroad.

The BOJ is the first central bank to go through these contortions, because Japan’s institutional investors have been the longest exposed to extraordinarily low bond yields. Germany joined Japan with sub-1% 10-year yields in 2014; both countries are now below zero. Even the U.S. has seen bond yields test historic lows, with potential for further declines, given the latest weakness in economic data and the likelihood that the Federal Reserve will cut interest rates again.

Others, too, may want to watch what Japan does: Australia’s central bank chief, Philip Lowe, has noted the pain to savers from the rate cuts he’s enacted. Aussie 10-year yields this year joined the sub-1% club.

“For now, Japan’s problem is unique, but if low rates are prolonged, which I think they are likely to be, this will be a serious challenge for the U.S. and other nations,” Kanno says. “The bottom line is that the global economy is facing the question of how we are going to live” without interest income on safe assets such as government bonds, he says.

Whatever the chance of the BOJ’s success with this new push, now’s the time to make the attempt, Sony’s Kanno argues. After all, Japan and the global economy aren’t in recession, and the job market is strong. “The BOJ is walking on a tightrope, but in hindsight it could be seen as a good time. Because they may end up where there is no rope.”—With Tomoko Sato

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