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BN 00:01 Is the BOJ Serious About Boosting Money Supply?: David DeRosa
Is the BOJ Serious About Boosting Money Supply?: David DeRosa
(Commentary. David DeRosa, president of DeRosa Research &
Trading, is also an adjunct finance professor at Yale School of
Management and the author of ``In Defense of Free Capital
Markets.'' The opinions expressed are his own.)
New Canaan, Connecticut, Oct. 3 (Bloomberg) -- Commercial
bank reserves held at the Bank of Japan more than doubled last
month to 12.4 trillion yen ($103 billion). This was no accident
-- the BOJ purposely created bank reserves to expand the money
supply.
Moreover, some of that surge in this important component of
the monetary base came via unsterilized currency intervention,
something the BOJ has been loath to implement. The monetary base
consists of currency in circulation and reserves held by
commercial banks at the central bank.
So why did the BOJ finally see the light? For years the BOJ
has ignored the advice of practically every economist I know. One
of the many problems plaguing Japan is deflation --- prices of
goods and services are falling.
Economists told the BOJ that to stop consumer price deflation
it would have to be aggressive in raising the anemic rate of
growth in the monetary base.
The basis for the recommendation is the quantity theory of
money, an idea nearly as old as the economics profession itself.
In Japan's case, the quantity theory asserts that if the central
bank creates money fast enough the prices of consumer goods will
have to stop falling and begin to rise.
In the special case of Japan, the solution to some problems -
- certainly not all of the problems, is moderate inflation. The
funny thing is that in my lifetime of studying economics I've
never before heard economists prescribe inflation as a remedy.
Real is Real
To see why this might work you have to consider another old
concept, the real rate of interest.
The real rate is the nominal rate of interest -- the rate you
see quoted in the marketplace -- adjusted for the expected rate of
inflation or deflation. When the prices of goods and services are
expected to rise the real rate will be less than the market
interest rate.
Japan's situation is the opposite. Falling prices create a
real interest rate higher than market rates. Economists consider
the real rate important because it is a better indicator of the
true cost of borrowing money.
If the quantity theory is correct, the explosion in Japan's
monetary base ought to eradicate deflation, maybe even cause some
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inflation, and, by extension, drop the real rate of interest.
Sounds good to me. And there is already a sign that it may be
working. Since the end of August there has been a slight
steepening of the Japanese term structure, though this is more
visible if you use the beginning of June as a comparison point. I
would expect the yields on Japanese bonds to rise as the market
begins to expect deflation will turn into inflation.
A Reversal?
The unsterilized intervention also matters because it could
be a signal that policy has changed in a serious way.
When a central bank intervenes to buy foreign currency, in
this case the dollar, it creates commercial bank reserves. This is
basically the same thing as a traditional open market operation,
though with the latter the central bank buys domestic government
bonds.
If a central bank doesn't want foreign exchange intervention
to affect the money supply it conducts a second operation. In the
BOJ's case, the second operation, following the purchases of
foreign assets, is to sell domestic government bonds, removing the
reserves created by the intervention.
The important thing is that unlike in the past, the BOJ
conducted unsterilized interventions in September.
That much we know. What we don't is why the BOJ is doing
this. The first theory is that the BOJ has finally arrived at a
point where it agrees that quantitative easing is necessary.
Better hope this is the right theory.
The second theory is that the BOJ, like many other central
banks, flooded the banking system with liquidity after the Sept.
11 terrorist attacks on New York and the Pentagon.
What's Going On?
Worst of all is the third theory: The BOJ is helping weaken
the yen for some kind of uniquely Japanese accounting reason.
Sept. 30 was the end of the first half in Japan's accounting
cycle.
You can see what the BOJ is doing by visiting its web site
boj.or.jp. The item called current account balances
is BOJ-speak for commercial bank reserves held at the central
bank. It is reported one day after the fact. When I went to the
site on Monday, the reserves were 12.4 trillion yen.
What makes me wonder how serious the BOJ is about the new
program is that today they report the number is 10.4 trillion yen
--in other words, the BOJ has let the monetary base drop by about
2 trillion yen since Oct. 1.
To be honest, I don't know what this means. It's only two
days. But if the BOJ is now in the process of reversing itself
(yet again) by draining the extra liquidity it created in
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September, then I say that central bank is hopeless.
--David DeRosa through the Tokyo newsroom at
dderosa@bloomberg.net or (203) 801-4340/pv/*jmw
Story Illustration: To see a graph of the value of the Japanese
yen against the dollar enter {JPY <Crncy> <GP> <GO>}
To see books published by Bloomberg Press, including ``In Defense
of Free Capital Markets,'' see {Book <GO>}
News by category:
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-0- (BN ) Oct/03/2001 4:01 GMT
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Copyright (c) 2001, Bloomberg, L. P.
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