I don’t really know much about Japan; only what I’ve read in the blogosphere that has said that Japan is the poster child for bad monetary policy. By the looks of the graphs I’ve seen of NGDP, inflation, nominal interest rates, etc… it looks pretty bad – and what I’ve read appears to be roughly on the mark.
The interesting thing about the news coming out of Japan yesterday, that it is finally tackling deflation head-on, is that it spurred a discussion about the interaction of interest rates with shifts in monetary policy. Scott Sumner had some explaining to do about his theory, which seemed confusing since nominal interest rates actually fell on the news that the BOJ would be doubling M2 over the next two years.
But I don’t think he is wrong or even confusing when he has said that low interest rates are a sign that money has been tight. What the plunge in nominal rates in Japan was telling me, but I could be wrong, is that money is currently so tight in Japan, that it is still tight even after factoring in doubling of M2.
Remember the Sumner quote I pulled out in my last post that discusses not knowing the extent to which we are at the ZLB because of various Fed mishaps?
Keep the existing 2% inflation target, but shift to level targeting. That might (or might not) allow us to avoid the zero bound. In other words, it’s not clear the extent to which we are at the zero bound because our inflation target is too low, and the extent we are there because the Fed allowed deflation in 2009, and didn’t attempt to make up the lost ground. Even better, shift to NGDPLT.
Multiply that bit of uncertainty by how long Japan has been mired in tight money, including premature exits from monetary stimulus when it has been attempted from time to time. It’s nice that the BOJ is now under new management – but it seems like the announcement it made may not have been believed to the extent it may be serious about what it intends to do.
And it should be part of the awareness in analysis of market reactions to shifts in Japanese monetary policy that the BOJ has said that it is targeting inflation at 2%. That is a very ambitious target considering the starting point, but it probably is too low and money will still be tight.
The recent tale of the transformation of the BOJ is rather extraordinary. It reminds me of some of the things being said about the European crisis. It seems to be going on forever. We wonder how long it will go on until the beginning of the end arrives and then it will vanish. And then we will wonder how the end can happen so fast. It is probably happening in the case of the BOJ being under new management that is eager to ditch tight money. We wondered how long Japan could go on with lost decades, and when the end arrived the expedience of it seems barely believable.
When I had my bout of unemployment, it went on so long it seemed at times like I would never work again. And that was only a few years. My new job came out of the blue, landed in my lap, and my personal crisis vanished with my first paycheck. It went on for what seemed like forever and was over very fast. But it took some time for my family to adjust and for that feeling of being on edge to dissipate.
Considering that the monetary crisis has gone on in Japan for 20+ years, with only brief periods of reprieve, and the new policy may need some digestion time. And so I don’t believe we can actually know what’s happening there by the immediate reaction of nominal interest rates. I don’t subscribe to the notion of long and variable lags, but I do think Japan might be a special case where it might take a lot of reassurance by the BOJ that it means exactly what it says, especially if taking into account the reputation of the institution and political instability in Japan. Things have to get better there rather quickly for the new policy to last.