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«I. Introduction The Institute for Monetary and Economic Studies (IMES) of the Bank of Japan (BOJ) held the 2014 BOJ-IMES Conference, entitled ...»

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Monetary Policy in a

Post-Financial Crisis Era:

Summary of the 2014 BOJ-IMES Conference

Organized by the Institute for Monetary

and Economic Studies of the Bank of Japan

by Ichiro Fukunaga, Daisuke Ikeda,

and Akira Otani

I. Introduction

The Institute for Monetary and Economic Studies (IMES) of the Bank of Japan (BOJ)

held the 2014 BOJ-IMES Conference, entitled “Monetary Policy in a Post-Financial

Crisis Era,” on May 28–29, 2014, at the BOJ Head Office in Tokyo.1 The conference was attended by some 80 distinguished participants from academia, international orga- nizations, and central banks.2 The participants discussed monetary policy issues raised by the recent financial crisis and its aftermath.

The conference began with opening remarks delivered by the Governor of the BOJ, Haruhiko Kuroda. An honorary adviser of the IMES, Marvin Goodfriend (Carnegie Mellon University), gave the keynote speech; David A. Lipton (International Mone- tary Fund) gave a guest speech; an honorary adviser of the IMES, Maurice Obstfeld (University of California at Berkeley), chaired a policy panel discussion; and five pa- pers were presented.

Ichiro Fukunaga: Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: ichirou.fukunaga@boj.or.jp) Daisuke Ikeda: Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: daisuke.ikeda@boj.or.jp) Akira Otani: Associate Director-General, Head of Economic and Financial Studies Division, Institute for Mone- tary and Economic Studies, Bank of Japan (E-mail: akira.ootani@boj.or.jp)

1. On behalf of the conference organizers, we would like to express our sincere gratitude to the IMES’s honorary adviser Marvin Goodfriend, the former honorary advisor Maurice Obstfeld, the chief councillor Kazuo Ueda, and all other conference participants for thought-provoking presentations and discussions. We also would like to thank the IMES’s former Director-General Tomoo Yoshida and other staff members of the IMES who devoted much energy to organizing this conference. The views expressed throughout this summary are those of the speakers and do not necessarily reflect those of their respective institutions. All remaining errors are our own.

2. See Appendix 1 for the program. See Appendix 2 for the list of participants; their affiliation is as of May 28–29, 2014.


–  –  –

In his opening remarks, Kuroda first provided a brief summary of views regarding the changes in the role of central banks from their establishment up to the recent global financial crisis. Then he mentioned three major lessons to be learned from the recent crisis and its aftermath. First, stability of the economy as a whole could not be achieved just by stabilizing prices and the real economy. Stabilization of the financial system also mattered. Second, it was possible to implement monetary easing even in a situation where the policy rate was around zero percent. Central banks in advanced economies had been underpinning economic recovery in the wake of the recent global financial crisis by using unconventional policy tools, such as asset purchases and forward guidance. Third, related to the second lesson, expectation management through communication with the market was critical to guiding the economy toward recovery.

Next, he raised three issues that had been revealed by the three lessons and needed to be resolved in the future. The first issue was how to achieve both price stability and financial stability, which could be rephrased as the issue of the division of roles between monetary policy and macroprudential policy. The second issue related to the effectiveness of forward guidance in expectation management, which depended on the strength of the commitment and future policy flexibility. The third issue concerned differences between the international spillover effects of conventional and unconventional monetary policy.

III. Keynote Speech: Federal Reserve Monetary Policy as a Carry Trade4 Goodfriend discussed a central bank’s operational credibility for monetary policy and derived policy implications on the use of interest on reserves at the zero interest lower bound. He first discussed what a central bank must do to acquire operational credibility for monetary policy against deflation and inflation at the zero lower bound. Ordinary interest rate policy powers were severely attenuated at the zero lower bound, and the operational credibility against deflation necessitated a willingness to expand reserves to purchase long-term securities on an unprecedented scale. He emphasized the critical role of interest on reserves in securing operational credibility against both inflation and deflation. Interest on reserves enabled a central bank to raise short-term interest rates without first shrinking its balance sheet. A central bank that expanded bank reserves to gain operational credibility against deflation must also be prepared to increase market interest rates quickly and aggressively by raising interest on reserves to secure operational credibility against inflation. The credibility against inflation, in turn, secured credibility for aggressive monetary policy against deflation at the zero lower bound.

He then assessed the recent actions undertaken by the Federal Reserve (Fed) and derived policy implications. He argued that the Fed’s monetary policy at the zero lower bound should be conceived as a “carry trade,” in the sense that it involved the acquiFor details, see Kuroda (2014).

4. For details, see Goodfriend (2014).

–  –  –

sition of higher-interest long-term securities in exchange for the issuance of lowerinterest reserves. It should be noted, however, that to secure credibility against inflation, the Fed would have to carry the acquired long-term securities by paying interest on reserves in line with market interest rates even after the interest rate policy exited the zero bound. The interest on reserves would be likely to accompany a negative cash flow problem on the Fed’s carry trade as short rates and interest on reserves rose above the coupon interest that the Fed earned on its long-term securities. If this occurred, the credibility of the Fed’s anti-inflation policy would be jeopardized. From this perspective, he argued that a central bank should retain net interest income on the front end of its carry trade at the zero lower bound against expected interest costs on the back end when the short-term interest rate rose to facilitate its operational independence and to attain operational credibility for monetary policy. He pointed out that despite the negative cash flow problem, the Fed had chosen not to retain surplus capital above its modest longstanding level even though its assets would have risen from US$1 trillion in September 2008 to around US$4.5 trillion by the end of 2014. In conclusion, he recommended that Treasury securities acquired by the Fed be exempted from the federal debt ceiling to facilitate retention of the Fed net interest income against its carry trade.

IV. Guest Speech: From Deflation to Reflation: Japan’s New Monetary Policy Framework, Effectiveness, and Broad Lessons5 Lipton assessed the progress in exiting deflation under the BOJ’s quantitative and qualitative easing (QQE), after reviewing the 15-year-long deflation that Japan had experienced. Then he drew some lessons for other countries facing deflation risks as well as for the BOJ’s next steps. He also commented on QQE from the view of the role of International Monetary Fund (IMF) in monitoring the effects of its member countries’ policies on the global economy.

He first reviewed the developments in Japan’s economy preceding the adoption of QQE. The long deflation had been caused by several factors including the collapse of the bubble, balance-sheet repair in the banking system, the Asian Financial Crisis, and the decline in investment and risk aversion. Demand-management tools including monetary and fiscal policy had been deployed but had failed to break the deflation.

Then he explained that QQE differed from what had been tried before in that it was a bigger and bolder commitment aimed at shifting expectations, additionally it was complemented by fiscal and structural reforms to lift growth expectations and support price momentum. The aggressive and concerted policy action had a pronounced immediate effect and inflation had indeed been making steady progress toward the 2 percent target. Meanwhile, he cautioned that it was too soon to declare success, and pointed out some challenges as the BOJ plans its next steps. First, the BOJ’s communication strategy might still need to be refined further to close the gap between the market’s medium-term inflation forecast and the forecast by the BOJ’s Policy Board members.

Second, cooperation with concrete growth and fiscal strategies was even more critical to overcome the still-widespread passivity and low appetite for risk-taking in Japan’s

5. For details, see Lipton (2014).

3 economy and to support QQE in its efforts to place inflation on a secure upward path toward 2 percent.

Next, he mentioned lessons pertaining to other countries that were currently facing deflation risks. In particular, the euro area economy had been slow to recover from the global financial crisis, although the European Central Bank (ECB) had proactively and aggressively taken measures to deal with this situation. Some economic conditions in the euro area mirrored those of Japan at the onset of deflation. He argued that the euro area should remain ahead of the curve and consider forceful actions before low inflation became entrenched to guard against the risk of deflation.

Finally, he assessed QQE in view of the IMF’s role. The IMF was mandated to monitor whether policy actions of its member countries led to spillovers that might have a significant impact on the global economy. The IMF had supported Japan’s efforts to use QQE even though the policy had led to yen depreciation as a side effect.

He referred to three factors on which the IMF’s judgment was based. First, Japan had few alternative policies to escape deflation and reach its inflation target other than QQE.

Second, while the weaker yen might have had some adverse impact on neighboring countries and the rest of the world, the policy impact must be temporary in nature.

Third, Japan needed to complement its QQE with other policies that supported reflation to avoid relying too much on QQE and its short-term impact on the real exchange rate.

He argued that there was little doubt that successful QQE and an escape from deflation would have meaningful positive spillovers to the global economy over the medium to long term, and thus it was necessary to weigh short-term negative spillovers against potential medium- to long-term positive spillovers.

From the floor, Takatoshi Ito (National Graduate Institute for Policy Studies) argued that the effect of QQE on the exchange rate was sort of a correction of an overappreciation of the yen and that QQE was not an active depreciation policy. Koichi Hamada (Yale University) pointed out that any country under a flexible exchange rate could counteract and offset the short-term negative spillover effects of monetary expansions of other countries.

V. Paper Presentation Sessions

A. We Are All QE-sians Now6 In the wake of the recent global financial crisis, the Fed, the ECB, and the Bank of England (BOE) had adopted unconventional policies that had expanded their balance sheets. The BOJ had also increased its balance sheet by introducing QQE in 2013. Ito called these policies as “quantitative easing (QE)” and conducted an empirical analysis of the effect of the BOJ’s QQE and its QE during 2001–06. In his terminology, QE meant increasing the size of a central bank’s balance sheet and maintaining the increased size. In this sense, the four major central banks were all “QE-sians” now. His broad terminology of QE contained two types: pure-QE and credit easing. The former emphasized the size of a central bank’s balance sheet, while the latter stressed its comFor details, see Ito (2014).

–  –  –

position. A representative example of pure-QE was the BOJ’s QE during 2001–06. A typical example of the credit easing was that introduced by the Fed at the onset of the failure of Lehman Brothers. The QQE adopted now by the BOJ had both elements of pure-QE (a large-scale expansion of the BOJ’s balance sheet) and credit easing (the BOJ’s purchases of ETFs and Japan real estate investment trusts (J-REITs) as well as the extension of the average remaining maturity of its purchases of Japanese government bonds). According to his empirical analysis, the BOJ’s QE—including QQE— lowered long-term rates and depreciated the yen through an increase in the monetary base in Japan. In addition, QQE strongly raised stock prices through not only the public anticipation of the BOJ’s introduction of a new policy framework after November 2012 (when the House of Representatives was dissolved), but also the public surprise concerning the greater than expected change in the BOJ’s actual policy framework introduced in April 2013. Furthermore, QQE had successfully raised inflation expectations and made the Phillips curve steeper in Japan. Finally, Ito mentioned that potential losses in central banks’ balance sheets during the exit process from QE might threaten central banks’ independence and argued that an explicit agreement between the central bank and the fiscal authority to cover the losses was desirable.

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