With many aspects, a distant perspective can be quite enlightening. This certainly applies to monetary policy, in my view. The more I distance myself, the more evident it becomes that for some central banks, debt management, rather than inflation – as officially proclaimed – is their primary objective. Japan is a prime example.
Thirty years ago
Thirty years ago, the headline inflation in Japan, as illustrated in the chart below since 1980, has generally hovered around zero since 1994, aside from occasional fluctuations. It’s widely recognised that Japan struggles with inflation issues. From a central banking standpoint, this is problematic, though one might question the benefit of deliberately diminishing purchasing power. Nevertheless, even with zero percent inflation, businesses aim for profit and consumers continue to spend.
To find a period of sustained inflation above two percent, we must revisit the late 1980s and early 1990s. The Japanese economy was then perceived as youthful and dynamic. It seems the then Bank of Japan governor, Yasushi Mieno, believed that traditional tightening measures would be effective.
For context, in the early 1990s, the Bank of Japan’s policy rates peaked at an impressive six percent, with ten-year rates at a similar level. In stark contrast, the current policy rate stands at negative 0.1 percent, and the ten-year rate is a mere 0.67 percent. This is largely due to ‹yield curve control›, implemented since September 2016, now in effect for around 7.5 years. For historical comparison, the United States also employed a form of yield curve control earlier, but the period from 1942-1951 speaks volumes about its context.
As it stands, the Bank of Japan holds nearly 50 percent of all outstanding Japanese debt. My Bloomberg line doesn’t extend beyond 1999, but it’s safe to say such a situation was not the case in the early 1990s.
Elephant in the room
Now there’s one reason that justifies at least slightly lower interest rates than 30 years ago: Japan is not growing. Potential growth is estimated somewhere between 0 and 0.5 per cent, but I suspect it is closer to the former than the latter number. In the early 1990s, economists still thought it was above 2.0 per cent, which was wrong. Anyway, as a central banker, you have to go with the data that is available.
The real elephant in the room is, of course, debt. In the early 1990s, Japan’s (gross) public debt stood at a neat 62 per cent of GDP. Effortlessly, Japan could have joined the Eurozone back then. For the record, Italy was already above 100 per cent back then. But now Japan’s debt stands at 253 per cent of GDP. Now, in the case of Japan, people are quick to point to the component of local government debt to the central government. One glance at China, with its Local Government Financing Vehicles, shows that this could easily put a big dent in economic activity.
Debt sustainability
To sum up, it is abundantly clear to me that central banks, desirable or not, are increasingly becoming the lender of last resort for governments that - whether the economy is doing well or not - are constantly overextending themselves. The Bank of Japan provides an abundantly clear picture of what the «solution» here is: structurally low or even negative interest rates. Good luck with that!
Jeroen Blokland is the founder of True Insights, offering independent research for building diversified multi-asset portfolios. Previously heading multi-assets at Robeco, his ‹Chart of the Week› is featured every Monday on Investment Officer Luxembourg.