The real meaning of the statement, “Avoid Hasty Tightening”

The thinking behind the monetary policies of Mr. Kazuo Ueda, whom the government is set to propose to the Diet on February 14 to be the next Governor of the Bank of Japan, will likely become increasingly clear during the Diet hearings to be held going forward. However, given that his responses before the Diet will be highly mindful of the political ramifications and of the reaction in the financial markets, they’ll likely begin and end with rather cautious wording. Indeed, the information we can glean from Mr. Ueda’s past writings or remarks might be more helpful for getting to know the real intentions behind his monetary policies.

The comment by Mr. Ueda that’s currently getting the most attention is the title of an article that was published on July 6, 2022 in the “Economics Classroom” section of the Nihon Keizai Shimbun, which read: “Japan, Avoid Hasty Tightening”. This is perhaps what will sell the conservative wing of the LDP, which is hostile toward monetary policy revisions, on accepting Mr. Ueda as the proposed new BOJ Governor.

In this article, Mr. Ueda asserted that even with the inflation rate exceeding 2%, the BOJ should be cautious about raising policy interest rates. His reason was that inflation over 2% is largely a result of temporary factors, namely overseas energy and food prices and the effects of the weak yen. Mr. Ueda is hesitant to proceed with raising interest rates like the central banks overseas are doing as a response to the inflation rate exceeding the 2% target, or perhaps in order to avoid worsening the yen’s depreciation.

Conversely, as the expected inflation rate rises (even temporarily) while prices are going up, maintaining policy interest rates at low levels would allow real interest rates to fall and let the BOJ enhance the effects of monetary easing, he argues.

This willingness to elicit the greatest possible monetary easing effects also overlaps Mr. Ueda’s stance back in the late 90s, when—after policy interest rates fell to near-zero levels—he sought to encourage long-term interest rates to drop in order to somehow elicit additional policy effects, and he spearheaded the promotion of the “policy duration effect” as a member of the BOJ’s Policy Board.

The need to revise the monetary easing framework

However, in this article, he pointed out for instance that “the framework for long-term interest rate control doesn’t lend itself to minute adjustments”, and he further argued for the need to revise the monetary easing framework, stating that “the future of our extraordinary monetary easing framework, which has lasted longer than most people expected, will probably need serious consideration at some point”.

It’s difficult to imagine that under the Ueda administration, the now decade-long extraordinary monetary easing program will suddenly be reversed and that short-term interest rates will be raised significantly. Even with his tools already limited, Mr. Ueda would surely endeavor to use monetary policy to support the economy to whatever extent he can.

On the other hand, we can expect that the next administration will want to logically analyze the effects and side effects of each individual policy of this non-traditional easing and then move forward with any necessary revisions. From this perspective, the major frameworks that have underpinned this monetary easing thus far—namely JGB purchases, Yield Curve Control (YCC), and negative interest rate policy—will likely all be the targets of this revision.

Pointing out the problems with the JGB purchasing and negative interest rate policies

In an essay contributed by Mr. Ueda to the October 2016 edition of the Securities Analyst Journal, titled “Negative Interest Rate Policies and Their Pros and Cons”, he took a negative view of the effects of so-called quantitative easing measures, by which the BOJ supplies money through JGB purchases. He was squarely rejecting the claims made by “reflationists” that by increasing the money supply, you can have a positive effect on the economy and prices.

Mr. Ueda is contending that if the government undertakes public spending while the BOJ purchases government bonds, following the so-called “helicopter money policy”, it could produce positive effects, but that would be nothing short of “government financing”, which can lead to a multitude of problems. In the December 2020 edition of the Nihon Keizai Shimbun’s “Economics Classroom”, Mr. Ueda also alluded to the limits of expansionary fiscal measures, stating that “one of the negative effects of having a high level of government debt outstanding that is continually growing is that it makes the economy vulnerable to rising interest rates”.

In his essay in the Securities Analyst Journal, Mr. Ueda stated that “(the negative interest rate policy) has been a harsh policy change for financial institutions, which have suffered under severely depressed lending margins as a result of protracted non-traditional monetary easing”, thus pointing out a side effect these policies have by dragging down financial institutions’ profitability. He also referred to the risk whereby, because JGB yields have fallen under the negative interest rate regime, the BOJ’s bond purchasing policy could lead to loss margins, which would ultimately erode the bank’s capital base.

While Mr. Ueda is probably cautious about substantially raising policy interest rates, he is likely also seriously concerned about this side effect that negative interest rate policies can create. From this standpoint, he will probably want to choose his timing carefully in eliminating the negative interest rate policy, and then look to change short-term policy interest rates to 0% or perhaps 0.1%. Even in that case, policy interest rates would still be at quite low levels, and monetary easing would still be in effect.

Further, in the Fukugan section of the Nihon Keizai Shimbun in April 2021, he also touched on the need for amending YCC, offering that “Basically limiting guidance to bonds with interest periods of less than ten years, and letting ten-year bond yields fluctuate freely, would likely suit the BOJ’s way of thinking”.

Will the BOJ set 2% as its medium-to-long-term price stability target?

The fact that the BOJ has stuck with its 2% price stability target, which is extremely tough to achieve, has in some sense made the bank’s monetary policies excessively rigid. Whether or not the BOJ amends this 2% price stability target will likely be what determines how far the monetary easing framework can be revised under the Ueda Administration.

We can infer that Mr. Ueda will likely have a positive attitude toward considering revisions to the 2% price stability target. In the aforementioned July 6, 2022 edition of the “Economics Classroom” in the Nihon Keizai Shimbun, he asked “In the first place, why should we aim for a sustainable 2% inflation rate?”, questioning the appropriateness of the 2% price stability target.

Furthermore, in the August 20, 2018 edition of the “Economics Classroom”, he stated in the section “Focusing on the Conflict Between Easing Effects and Their Side Effects” that “achieving 2% would reasonably be more of a medium-to-long-term target”, suggesting that he believes the 2% price stability target ought to be repositioned as a medium- and long-term goal.

How to regard the 2% price stability target will likely be a main aspect of the discussion between the government and the BOJ about revising its joint statement, which is set to begin in April at the earliest. Even if the status of this target is not explicitly amended in the context of this revision, it’s still possible that such an amendment will be made.

Will revision of the monetary easing framework and normalization be pursued with caution?

Similarly to when he was on the Policy Board, Mr. Ueda will likely focus on ways to support the economy through monetary policy even with limited tools at his disposal. On the other hand, he will probably abstain from totally rejecting the policy path of Governor Kuroda, instead calmly analyzing the effects and side effects of each individual monetary policy, and then enacting measures to mitigate the side effects as necessary, to maximize the net effects minus those side effects. That will lead to a comprehensive revision of the monetary easing framework. However, it’s likely that even with that approach, the revision will entail not tightening Japan’s monetary policy, but rather keeping monetary easing in effect.

Mr. Ueda likely also expects that amending the monetary easing framework will lead the country’s monetary policy to regain their flexibility, and bring back some room for making minute adjustments in keeping with the economic and financial market environments.

Thus, we can expect that under the new Ueda Administration, the BOJ will carefully proceed with revising the monetary easing framework and normalizing its policies while giving full consideration to the stability of the financial markets and financial institutions. That work will likely be carried out together with the BOJ Secretariat. It’s anticipated that the “de-facto normalization” trend led by the Secretariat under Governor Kuroda will be carried through to the new administration, and will even be accelerated.

Mr. Ueda—stressing the importance of logic—has suggested that he’s inclined to distance the BOJ from the current extraordinary monetary easing program, which in a sense has been pursued without much detailed analysis of its effects and side effects, and which has even leaned heavily on the element of "willpower". At the same time, he’s also given to providing explanations that are easy to understand. This suggests that Mr. Ueda is keenly aware of the problematic nature of the BOJ’s public explanations these days, which have been extremely complicated and difficult to understand, and even duplicitous.

From this viewpoint, I hope that under the new Ueda Administration, substantial progress will be made in normalizing the BOJ’s communication with the public and with the financial markets, alongside the normalization of its monetary policy (Column: “ Normalizing Monetary Policy and Communications at the Same Time is a Must for The Next Bank of Japan Governor”, Feb. 6, 2023).

• Takahide Kiuchi

  Executive Economist