UBS On The Erosion Of Central Bank Independence

Via UBS Investment Research

Erosion of BoJ Independence: “Fonetary-Policy”?

The erosion of the BoJ as independence and the implications for central banking

The Japanese government’s pressure on the BOJ for more monetary stimulus is clearly intensifying as the bank’s October 30th meeting approaches.

Why is the BOJ facing heightened pressure for more easing?

Last August the Japanese government passed a bill to raise the consumption tax from the current 5% up to 8% in April 2013 and to 10% in 2015. However, the government ultimately opted to make the tax hike contingent on the prospect of the Japanese economy emerging from its deflationary rut in the fall of 2013. Accordingly, the government is now seen as increasing pressure on the BOJ to do something to combat deflation, given that the Japanese economy is likely to post negative growth over the July–September quarter amid the economic slowdown in China and other such factors.

Is the BOJ really under pressure?

As it now stands, the BOJ has set a target for the Asset Purchase Program (APP) of ¥80tr by year-end 2013 from ¥63tr currently. Media sources have reported that the government is calling on bank officials to raise that amount by a further ¥20tr (Sankei newspaper, Oct 23). However, prior APP portfolio increases have always come in increments of between ¥5tr-¥10tr, so a ¥20tr increase would be equivalent to roughly 4% of Japan's annual GDP, or 14% of the BOJ balance sheet. Although many market players obviously remain skeptical that the BOJ might actually increase the facility by such a large amount, bank officials may have become more susceptible to pressure to initiate further stimulus measures.

What about legally-mandated BOJ independence?

The BOJ Act was revised in April 1998 to ensure that Japan's central bank would maintain its independence from the government. This was done to make it easier for bank policymakers to expeditiously fight inflationary pressures. The difficulty of managing policy at the zero interest rate bound, as evidenced by the BOJ’s seeming inability to push prices onto a positive trajectory, coupled with its diminished role as a financial intermediary (due to stagnant loan markets) have put the central bank on its back foot. Downward economic pressure following the 2008 financial crisis and the aftermath of the Tohoku earthquake and tsunami has compelled the bank to invoke further monetary accommodation. Lawmakers have also implemented aggressive spending programs with the intention of spurring economic activity. With sovereign debt ratios at very elevated levels, legislators are increasingly tempted to lean on monetary officials to provide further accommodation, to little avail.

Despite the monetary and fiscal pump priming which has taken place, the bank's 2014 (FY) CPI outlook is expected to fall short of the bank's 1% inflation goal set back in February. This factor, coupled with the increased perceptions of political pressure, has raised market expectations that further measures will be forthcoming at the October 30 meeting.

Why is the BOJ seen as hesitant to provide more easing?

Until now, BOJ monetary easing measures have been linked to the prospect of increased sovereign debt investment by financial institutions (Figure 1). The monetization implemented by the central bank finds its way into the banking system and then, rather than getting re-circulated into risky assets such as loans, ends up invested in the JGB market.


Such moves have not reduced real interest rates through heightened inflationary expectations, nor have they brought about increased private-sector investment through lending. The BoJ’s unsuccessful efforts to stimulate inflation using these tools has likely heightened scepticism that further monetary easing of this same nature will be able to bring about an end to deflation. Ongoing and accelerated purchases of government bonds by the BOJ also poses the danger that such moves could be perceived as central bank financing of government spending, particularly given government lacking progress with financial reconstruction initiatives.

BoJ Independence or Interdependence?

There is a possibility that the realm of monetary policy could increasingly merge with that of fiscal policy and national debt management policy.“Fonetary-policy” – fiscal policy plus monetary policy.

The BOJ embarked on its strategy of quantitative easing from 2000 to 2006, engaged in a comprehensive monetary easing initiative commencing in 2010, and has been extending out beyond conventional T-bills to purchasing assets such as long-dated JGBs, ETFs, and J-REITs. Policy makers have been gradually exposing the bank to ever higher levels of price volatility risk.

Along those lines, an agreement could emerge that would put Japan on a trajectory toward a combined monetary and fiscal policy, which might look much like the regime which existed in the U.S. prior to 1951. From 1942 to 1951, the Fed agreed to support massive government borrowing to fund the war effort by purchasing sufficient amounts of Treasury debt to keep interest rates pegged at artificially low levels. The post-War economic expansion, brought about by returning veterans and a conversion of the economy from a war-time footing, ultimately kindled strong inflationary pressures and monetary policy makers were incapable of a response. After much acrimony, the 1951 Accord was agreed to, stipulating a division between fiscal policy and monetary policy in order to safeguard the economy from inflationary pressures.

Central Banks and Debt Managers: Embracing a Negative Dynamic

Globally, central banks are edging down monetary policy paths that can be viewed as increasingly backstopping budget deficits as lawmakers of respective governments continue to fail to make progress toward fiscal consolidation. A progression down this road could lead to many unsavoury outcomes, as fiscal and monetary policies entwine themselves in an increasingly negative dynamic.