Here’s Noah Smith at Bloomberg:

Japan’s great monetary policy experiment is drawing to a close, and the results may change the way the world thinks about central banking. The Bank of Japan’s recent quarterly report says, in effect, that the central bank has done all it can do to raise growth and inflation, and that fiscal policy needs to step in and help. The BOJ admitted that monetary policy alone won’t be enough to hit its 2 percent inflation target, now or ever.

This is very troubling for monetarists (as those who think that monetary policy is the key to macroeconomic stabilization are sometimes called). If central banks can’t control the rate of inflation, what hope do they have of affecting the economy?

I was surprised to read that the BOJ’s quarterly report had said that the BOJ had done all it could, particularly since the head of the BOJ frequently says exactly the opposite.  So I followed the link to the “quarterly report” and found . . . another Bloomberg article:

Many economists interpreted a BOJ policy shift in September as preparation for a sustained fight to generate inflation. Shirai said the central bank would maintain the status quo on policy unless the yen surges or economic data deteriorate.

And what will it do to policy if the yen “surges”?  Let me guess, it will ease policy. So why not ease policy today?

In fact, the BOJ denies that it is out of ammo.

Market monetarists have been more accurate in their Japan forecasts than any other group.  I believe that I was the first western blogger to comment on Abenomics, and I consistently predicted that the policy would raise inflation, but not all the way up to 2%.  That’s been my view all along, and that’s exactly what’s happened.  The actual inflation rate has averaged closer to 1.0%, but even that is a dramatic improvement over the deflation that preceded Abenomics (and this occurred during a period of rapidly falling oil prices, when even US inflation underperformed).  I also pointed out early in 2016 that the BOJ was moving to a more contractionary policy, and we now see the effects of that policy switch on Japanese inflation, which has fallen.  Even so, the impact of Abenomics on NGDP is clearly positive.  It began rising almost immediately after Abenomics was announced in late 2012:

The rest of the article makes the usual mistakes, confusing low interest rates and QE with easy money, whereas they are usually reflective of the fact that the central bank policy is too contractionary.  The market monetarist solution now is the same as it always was—NGDPLT—combined with a “whatever it takes approach” to monetary stimulus.  If you want a smaller central bank balance sheet, then aim for a higher NGDP growth target.  This is not rocket science; we know how to do it, we just need to get real world central banks to try.

But don’t let the perfect be the enemy of the good.  Abenomics really was much better than what came before, and we can do still better.  Instead of abandoning monetary policy, why not improve it?

There’s another thing I don’t understand about all these “monetarism has failed” articles—where are all the “Keynesianism has failed” articles? Didn’t Japan do massive fiscal stimulus, causing it’s debt to balloon to 250% of GDP?  Why isn’t fiscal stimulus viewed as a failure?  I suppose a Keynesian would say, “well they should have done even more”?  OK, but why doesn’t that also apply to monetary stimulus?  After all, fiscal stimulus is far more costly. In contrast, there’s no limit to how much money can be printed.  And why do we get this:

If Japan is out of the monetary easing game, other countries will doubtless follow. The era of bold monetary policy experimentation that began with the global financial crisis is now drawing to a close. More and more, economic policy makers will look to fiscal initiatives and to deeper structural reforms to boost growth and stop deflation.

Why not say the failure of fiscal stimulus in Japan means that governments are “out of the fiscal game”?  In fact, governments can never be out of the monetary policy game, unless they revert to barter.  As Nick Rowe likes to point out, there is no such thing as not doing monetary policy.  The only question is where are you going with that policy.  If you have a policy that delivers low NGDP growth rates and near zero interest rates, then you will end up with a big central bank balance sheet. There’s no way to avoid that except by aiming for a higher NGDP target.  Fiscal policy doesn’t create any short cut to success, as the Japanese case already showed. In January 2015, the Swiss tried to “get out of the monetary policy game” so they could shrink their balance sheet, and the balance sheet is now bigger than ever.  If you are going in the wrong direction, then switch policy.

If any central bank was going to fulfill the dreams of monetarists, it was Kuroda’s BOJ.

Actually, Australia’s much closer to what monetarists have in mind, unless you consider letting the yen appreciate from 125 to 100/dollar to be a monetarist “dream”.

Here’s another article on the BOJ, from last month:

“We are buying government bonds to achieve the 2% price target,” Kuroda said.

Kuroda said that he doesn’t expect the BOJ to run out of JGBs to purchase.

He said that the BOJ’s easy policy would not lead to hyper-inflation.

PS.  Stephen Kirchner sent me to this. Great idea, do massive fiscal stimulus when unemployment is 4.9% and the Fed is raising rates to prevent an overshoot of 2% inflation.  Why didn’t I think of that? I often say that talking about politics takes 30 points off a person’s IQ (including me).  I have a new one.  The zero bound takes 30 years of progress away from macroeconomics.  It took macro 30 years to recover from the Great Depression, and it’ll probably take 30 years to recover from the Great Recession. I won’t live that long.

🙁

The BOJ’s recent decision is likely to end up being far more important than anything the Fed does or does not do today.  But as of now it raises more questions than answers:

1.  The BOJ announced it would cap 10-year bond yields at 0%, and also that it would attempt to overshoot its 2% inflation target.

2.  The BOJ did not announce lower IOR or more QE.

Today’s market reaction is hard for me to gauge.  The initial reaction was clearly positive, as stocks rose nearly 2%, and the yen fell by almost 1%.  Later, however, the yen more than regained the ground it lost.  That doesn’t mean the BOJ action had no impact, just that whatever impact it had was at most slightly more than markets anticipated.

The overshoot promise could be viewed as either Krugman’s “promise to be irresponsible”, or as a baby step toward level targeting.  Martin Sandhu gives a third interpretation—a signal that the target really is symmetrical, despite all the talk about a de facto 2% inflation ceiling in many countries.  There’s no reason that all three interpretations could not be a little bit true—after all, central bank policy is made by committees.

I vaguely recall Bernanke suggesting something like a long term interest rate peg—can anyone confirm?  I have mixed feelings about this idea.  On the one hand, I like moving monetary policy away from a QE/negative IOR approach, and toward a price peg approach.  But I view interest rates as almost the worst price to peg, for standard NeoFisherian reasons.  Are low long-term rates easy money, or a sign that money remains tight?  That’s not at all clear.

Although I am disappointed by the specific steps taken today, these actions do make me more optimistic in one sense.  The BOJ has shown that it’s still willing to experiment, and that it still wants to raise inflation.  Here’s an analogy.  When the Fed first engaged in forward guidance, they did so in a very ineffective manner—low rates for X number of years.  This was criticized as being rather ambiguous—in much the same way the BOJ’s 10-year bond yield cap is ambiguous.  So the next step in forward guidance was to make the interest rate commitment conditional on the economy, a major improvement.  Perhaps the BOJ’s next step will be to switch to price level target, in order to make the size of the inflation overshoot more concrete.  Or maybe instead of capping 10-year bond yields, they’ll peg something more unambiguous, such as the yen against a basket of currencies.  If that’s too controversial (and it probably is) then peg the yen against a CPI futures contract.

The danger is that this specific move won’t work, and the backlash will prevent the BOJ of moving further down the road in the future.  Maybe that’s why the yen reversed course a few hours later.

PS.  It just occurred to me that the 10-year bond yield cap could be viewed as a sort of commitment to enact a policy expected to lead the yen to appreciate by at least 1.68%/year against the dollar (for standard interest parity reasons).  That’s a non-NeoFisherian way of explaining why I’m skeptical.  In the long run, this bond yield cap means that Japanese inflation is likely to be 1.68% lower than US inflation.  They really needed to do the opposite of what the Swiss did early last year—they should have sharply depreciated the yen, and simultaneously raised interest rates.

PPS.  Kudos to Paul Krugman.  Ideas that start out seeming very “ivory tower”, such as promising to be irresponsible, can end up being enacted, at least in part.  Unfortunately, Krugman first proposed that idea under the (quite reasonable) assumption that liquidity traps would be temporary.  The markets don’t seem to believe that any longer, at least with respect to Japan.

Update:  Kgaard added this comment:

Scott — My understanding is that at the post-announcement press conference Kuroda said he would not be upping the amount of monthly bond purchases, and this is what turned the yen. Seems to me that what you wrote a couple days ago is entirely relevant here: If they SAY they want 2% CPI but then take actions consistent with 0% CPI, then what they really are targeting is 0% CPI until further notice, and investors will respond accordingly. Hence stronger JPY …

Update #2:  from commenter Mikio:

Kuroda did not say he will not expand purchases. On the contrary. He repeated again that the BOJ is ready to expand both the purchases as well as cut the IOR. But obviously they did not think they need to act now.

I think the jury is out there about this move. It’s non-progress if you look at the yen, it’s marginally positive if you look at stock market.

Update#3:  HL added the following:

Kgaard and Mikio are both right / wrong

After the longest delay for the statement release, markets learned at 01:18 pm Tokyo time, the following:

No change in policy balance rate at -0.1%
Monetary base expansion until inflation stable above 2%
JGB purchases in line with the current pace
MB/NGDP rate to hit 100% in 1 year (currently 80%)
Yield curve control introduced
Average maturity target scrapped
10 year JGB yield target around 0%
Forward guidance enhanced
Inflation overshooting commitment
Purchases to fluctuate to achieve curve control
Continue easing until inflation stably above 2%
No mention of timeframe
Comprehensive review on policy
NIRP helpful for decline in funding rates
NIRP didn’t seem to change banks’ willingness to lend
NIRP’s impact on yield curve, however, a bit problematic

Then during the preso (03:30~04:42), Bloomberg headlines
03:39 pm “No change in commitment to achieve 2% ASAP”
03:44 pm “Cutting minus rates further is still an option”
03:55 pm “Don’t think BOJ is coming close to limits”
03:55 pm “We just strengthened our framework”
04:12 pm “Expect inflation to hit 2% during FY 2017”
04:22 pm “amount of bond buying changes with the economy”
04:29 pm “BOJ won’t have JPY 80 trillion for JGB buying as fixed”
04:40 pm “New framework isn’t tapering”

So immediately after the statement release, markets had reasons to believe that some guidance on quantity part could be provided by Kuroda (continuing the purchase, etc). Then during the preso, Kuroda made that guidance more ambiguous. But the fact is: there is nothing in these comments to suggest that the BOJ will start tapering soon.

USDJPY had its strongest period between the statement release and the start of the preso Q&A. Then it was on a gradual decline even before Kuroda started making comments related to the quantity dimension. Eventually it settled around 101.70 before declining sharply at the start of New York session…

During the first several years of Abenomics, the BOJ actively pushed monetary stimulus.  Their announcements were often more aggressive than expected, and the yen depreciated sharply on this news.  The inflation rate rose from negative territory up close to the 2% target.  This year, however, the BOJ seems to have given up on monetary stimulus.  Most of the recent announcements have been less aggressive than the markets expected, and the yen has appreciated from a low of about 125 to the dollar, to 105 as of yesterday.  Today the BOJ produced another disappointing announcement, much less than markets expected, and the yen plunged another 3%, to 102.  This is not rocket science,  If the BOJ allows a strong yen they will fail to hit their target.  If they do enough stimulus to dramatically weaken the yen, they can hit their target.  So why don’t they?

This also shows why we cannot rely on policy discretion.  Policymakers simply are not willing to carry out their instructions.  A CPI or NGDP futures targeting regime (level targeting) would solve the “problem”. Which is probably why it won’t be adopted.

Why did the BOJ allow this to happen?

PS.  It’s amazing how similar Abenomics is to FDR’s policies.  You have highly successful monetary stimulus which is abandoned for no good reason.  You have a weird mixture of fiscal stimulus and austerity.  And you have the government putting the cart before the horse, by trying to pressure firms to raise wages:

Openly pushing companies to raise wages is just one of the unorthodox economic policies attempted under the Abe government to jump-start an economy that seems stuck in a long-term rut.

I wish they’d go back to trying to raise NGDP, that’s the only durable way to get higher wages.

PPS.  Here is a typical media report on the BOJ:

But the truth is, at this stage, three years into his radical program to restart Japan, the BOJ might just be a spent force.

Face palm.

Yeah, the BOJ is out of ammo.  Maybe they can borrow some ammo from Zimbabwe.

James Alexander directed me to a very interesting Bloomberg article:

Ben S. Bernanke, who met Japanese leaders in Tokyo this week, had floated the idea of perpetual bonds during earlier discussions in Washington with one of Prime Minister Shinzo Abe’s key advisers. . . .

He noted that helicopter money — in which the government issues non-marketable perpetual bonds with no maturity date and the Bank of Japan directly buys them — could work as the strongest tool to overcome deflation, according to Honda. Bernanke noted it was an option, he said.

Though Honda said he thought Japan was already engaged in a strategy that involved helicopter money, he wanted to convey the idea to Abe and asked Bernanke to meet with the premier in Japan. While this didn’t happen in the spring, Bernanke joined central bank chief Haruhiko Kuroda over lunch this Monday and on Tuesday he attended a gathering with Abe and key officials, including Koichi Hamada, another influential economic adviser.

Bernanke at the Tuesday meeting said Japan should carry on with Abenomics policies by supplementing monetary policy with fiscal stimulus, according to Hamada. Bernanke told Abe that the BOJ still has instruments to further ease monetary policy, said Yoshihide Suga, Japan’s top government spokesman. The central bank didn’t reveal what Kuroda and Bernanke discussed.

I understand perpetual bonds (aka consols), but I don’t get the “non-marketable” part.  If the Japanese fiscal authorities financed their deficit with marketable consols, and the BOJ bought them in the free market, you’d have an ordinary open market purchase.  It would not be a helicopter drop unless tied to a simultaneous fiscal expansion.  But if tied to fiscal stimulus it would be a helicopter drop even if the bonds were not perpetual.  So is it the “non-marketable” aspect that makes it a helicopter drop?

If these bonds became a large share of the BOJ balance sheet, and if Japan ever exited the liquidity trap and rates rose above zero, then the BOJ might have to sell off the perpetual bonds to prevent hyperinflation.  But you can’t sell “non-marketable” securities—is that the idea?

Bond traders, stock investors and economists have been mulling the possible implications of Bernanke’s visit and the next steps to come in Abenomics. Amid intense speculation about the chances of helicopter money, and the certainty of further fiscal stimulus ordered by the prime minister, Japanese shares have rallied for four consecutive days while the yen has weakened.

Fiscal stimulus makes a currency appreciate, so the recent depreciation is more likely due to the anticipated monetary expansion.

PS.  A few months back Bryan Caplan suggested that governments issue marketable consols as a way of out the liquidity trap.  It’s impossible for the yield on consols to fall to zero:

Step 2: The central bank uses standard open market operations to bid up the price of consols until nominal GDP starts rising at the desired rate.

Notice: With regular bonds, the difference between 1% interest and .1% interest seems trivial.  With consols, it’s massive.  A fall from 1% to .1% multiplies the sale price of a consol by a factor of ten!  There is an even bigger difference between a 1% interest rate and a .01% interest rate.  That multiplies the sale price a hundred-fold.  Can we really imagine that this massive increase in the public’s net worth won’t translate into higher consumption and investment?  And if not .01%, how about .00001%?

The only limit, as far as I can tell, is that the central bank might inadvertently retire its national debt.  When the bond price gets high enough, everyone sells.  But this seems like a remote possibility.

I like this idea even better than the non-marketable approach.  I’m not certain that retiring the entire debt is a “remote” possibility, but then I don’t feel I have good intuition in this area.  If it is a remote possibility, then Bryan’s idea would seem to eliminate the zero bound problem.

Joe Gagnon is a former Fed economist now located at the Peterson Institute in Washington.  He’s also arguably the world’s leading expert on QE. The conversation with David was excellent from beginning to end.

Here are a few highlights (from memory):

1.  Gagnon’s research suggested that QE was somewhat effective at lowering long-term interest rates.  That’s also the consensus view of dozens of other studies he looked at.  He suggested that QE probably led to higher bond yields in the long run, which reflected the higher nominal growth of countries that engaged in more aggressive monetary stimulus.  He seemed to suggest this was a rather surprising result, but I think it’s in line with the previous views of monetarists like Milton Friedman.

2.  Gagnon likes NGDP targeting, and is somewhat split between growth rate and level targeting.  At one point he seemed to suggest an option somewhere between those two extremes.  I’d guess that reflects the behavior of the economy after 2007, when (in retrospect) a continued 5% NGDP growth rate might seem a bit too aggressive.

3.  He suggested that the Fed may have been held back around 2009-10 from doing even more QE by a fear of the unknown.  It was a new and untried policy instrument.  Gagnon also indicated that (in retrospect) it probably would have been better to do all three or four QEs right up front.  (I’m glad he said 3 or 4, as I’ve always been a bit unclear as to whether the first QE was in late 2008, or March 2009. It seems the leading expert also views the number of QEs as ambiguous.  The official number was three, but it seems like there were four.)

4.  David asked him about the options for monetary policy that he came up with as a researcher at the Fed during 2008-09.  I kind of regret not hearing him talk about whether the Fed looked at the options for Japan that were outlined in Bernanke’s 2003 paper.  There’s been a lot of criticism (from me and others) of the fact that Bernanke’s Fed did not pursue some of the more aggressive options that Bernanke recommended to the BOJ, in his famous paper that discussed the need for “Rooseveltian resolve.”  (Here I’m especially thinking of price level targeting.)  That’s not to say there are not good answers.  Bernanke got in hot water in 2010 for suggesting we needed to raise the inflation rate (to 2%).  If he had indicated a need to raise it to 3% or 4% to catch up to the trend line, the policy would have been even more controversial.

5.  Gagnon gave an excellent summary of recent events in Japan.  His view is similar to mine, but he’s followed things more closely and has much more knowledge of the situation.  The original Abe/Kuroda push for 2% inflation was partially successful.  Core inflation expectation quickly rose by about 200 basis points, from minus 0.75% to 1.25%.  They needed one final push, and in early 2016 tried to do so using negative IOR.  Unfortunately, the negative rate was only 0.1%, which was too little to have much effect.  Even worse, there was a political backlash.  That led the markets to lose confidence in the BOJ, and since then the yen has soared in value.  Thus inflation expectations are now coming down.  In retrospect, they would have been better off doing more QE.  Gagnon even suggested buying equities as an option.  He thought it was really important that the BOJ hit its 2% inflation target, and I agree.  That’s not because I favor inflation targeting (I don’t) but rather because I think it’s really important for central banks to hit their targets, for credibility reasons.  Unfortunately, it appears the Abe government has lost interest in this policy target.

6.  Gagnon pointed out that before the Great Recession most economists thought that a 2% inflation target would be enough to keep us away from the zero bound.  He also noted that early discussions of the pros and cons of a higher inflation target took account of the likelihood of hitting the zero bound.  Then Gagnon said something to the effect; “Well, we now know something new”.  We know that the zero bound problem can occur with a 2% inflation target.  So if economists thought that 2% inflation target was optimal for the US, then that can’t possibly be the case now.  Speaking for myself, I’m disappointed that so few economists are forcefully explaining why this new information suggests that we need a new target.  And it does not have to be 3% or 4% inflation, it could be NGDPLT.  But clearly some change is required.  And yet as far as I can see the Fed seems determined to continue muddling along with a 2% inflation target, which makes their “conventional” policy tool (interest rate targeting) almost useless going forward.

7.  Gagnon also did an excellent job explaining the problems with helicopter drops–it’s too effective if expected to be permanent.