BOJ's monetary policy - pivot to targeting yield curve

BOJ's monetary policy statement is an "interesting" read. Here is the link - https://www.boj.or.jp/en/announcements/release_2016/k160921a.pdf

A few points that are worth pointing out. Today BOJ has pivoted the 3rd time in the monetary policy that it started under the Abenomics regime.

From "Quantitative and Qualitative Monetary Easing (QQE)" which was launched in April 2013 and "QQE with a Negative Interest" which was launched 6 months ago - BOJ has now pivoted to "QQE with Yield Curve Control" today.

1) The monetary base in Japan is mind boggling. According to BOJ's statement - "The Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds the price stability target of 2 percent and stays above the target in a stable manner. Meanwhile, the pace of increase in the monetary base may fluctuate in the short run under market operations which aim at controlling the yield curve. With the Bank maintaining this stance, the ratio of the monetary base to nominal GDP in Japan is expected to exceed 100 percent (about 500 trillion yen) in slightly over one year (at present, about 80 percent in Japan compared with about 20 percent in the United States and the euro area)."

This defies the fractional-reserve banking system that we operate under in the capitalist economies. What happened to the money multiplier?

2) The experience so far with the negative interest rate policy shows that a combination of the negative interest rate on current account balances at the Bank and JGB purchases is effective for yield curve control. In addition, the Bank decided to introduce new tools of market operations which will facilitate smooth implementation of yield curve control."

"Possible options for additional easing

With regard to possible options for additional easing, the Bank can cut the short-term policy interest rate and the target level of a long-term interest rate, which are two key benchmark rates for yield curve control. It is also possible for the Bank to expand asset purchases as has been the case since the introduction of QQE. Moreover, if the situation warrants it, an acceleration of expansion of the monetary base may also be an option."

Well, the ultimate answer seems to be print more money.

3) What is the yeild curve target - seems to signify status quo on the long end. They seem to be nervous to bring down the long end of the curve.

"The short-term policy interest rate: The Bank will apply a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in current accounts held by financial institutions at the Bank.

The long-term interest rate: The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent). "

This statement below expresses their reluctance to bring the long end below zero.

"The impact of interest rates on economic activity and prices as well as financial conditions depends on the shape of the yield curve. In this regard, the following three points warrant attention. First, short- and medium-term interest rates have a larger impact on economic activity than longer-term rates. Second, the link between the impact of interest rates and the shape of the yield curve may change as firms explore new ways of raising funds such as issuing super-long-term corporate bonds under the current monetary easing, including the negative interest rate policy. Third, an excessive decline and flattening of the yield curve may have a negative impact on economic activity by leading to a deterioration in people's sentiment, as it can cause uncertainty about the sustainability of financial functioning in a broader sense."

"To work toward the formation of an appropriate yield curve, the Bank should take account of economic, price, and financial conditions, including (i) the extent to which a decline in JGB yields translates into a decline in lending and corporate bond rates, (ii) the effects of a decline in JGB yields on economic activity, and (iii) the impact of a decline in JGB yields on financial functioning."

Hence it clearly signifies the reluctance in BOJ to push down the long end below zero at present. What does this mean? If the world slows down further, and the 10yr is getting negative - will BOJ significantly reduce buying assets? They will be caught in that dilemna as there are conflicting forces at play, and they dont seem to be ready to go there at present.

One conflict is clearly visible in the following statement- " Given the fact that both observed and expected inflation rates are below 2 percent currently, the Bank judged it appropriate to enhance the credibility for the price stability target among the public by committing itself to expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner."

Hence the twin targets are:

1) Yield Curve control - Short term below -0.1%, long term at zero.

2) Inflation to target 2%.

Finally - This statement sums it well - "Thus, the Bank adheres to its commitment to achieving the 2 percent inflation at the earliest possible time. Meanwhile, a further rise in inflation expectations through the adaptive mechanism is uncertain and may take time. Considering these, the Bank judged it appropriate to adopt a new policy framework with the mechanisms for yield curve control placed at the core that enables the Bank to make more flexible adjustments according to developments in economic activity and prices as well as financial conditions and that enhances the sustainability of monetary easing."

Read another way - we have no idea when we can affect inflation, so lets target yield curves instead.