Nomura´s Richard Koo of ‘Balance Sheet’ Recession’ fame is desperate that his theory is being put to the test and is losing ‘face’. According to Ambrose Evans-Pritchard:
As I reported last night, Mr Koo thinks the Abenomics plan of monetary reflation is madness. “Once inflation concerns start to emerge the BoJ will be unable to restrain a rise in yields no matter how many bonds it buys.” This could lead a “loss of faith in the Japanese government” and the “beginning of the end” for Japan’s economy.
He´s probably right with “beginning of the end for Japan´s economy”, if by that he means (which he doesn´t) that deflation will finally end and growth will pick up.
For too long monetary policy has been synonymous with interest rate policy. For example, at every round of QE Bernanke would say the objective was to drive down interest rates over the whole term structure. Curiously, the exact opposite happened as the chart illustrates.
The go-stop nature of QE reduces its effectiveness. The more recent ‘threshold contingent QE’ is a step in the right direction but, given the objects that make up the thresholds, has been causing ‘communication glitches’.
In Japan, given the more than two decades of low and sometimes even falling rates, the bond market took a little longer to ‘wise up. Yields fell for several months after Abe´s policy change announcement but for the past two weeks, following much better than expected growth news, they have soared as the market begins to realize that monetary stimulus designed to get rid of deflation has already managed to stimulate the economy.
As the charts show, the stock and foreign exchange markets were much quicker on ‘the draw’.
The big drop in the Nikkei on Thursday made headlines and some were quick to say “the end is near”.
Note, however, that after Abe´s election and up to May 22 (the day before the big drop), the volatility of stock prices had increased significantly. That usually happens during ‘state transitions’. Sometimes, doubts about the permanence of changes overwhelm market participants. It’s up to the PM and the BoJ to ‘stay the course’.
They could improve the situation enourmously if instead of having a 2% inflation target they announced an NGDP level target, as the following chart indicates.
Update: David Glasner explains the hightened sensitivity of markets in Japan:
[But] let’s just suppose that the Japanese, having experienced the positive effects of monetary expansion and an increased inflation target over the past six months, woke up on Black Thursday to news of Bernanke’s incoherent testimony to Congress suggesting that the Fed is looking for an excuse to withdraw from its own half-hearted attempts at monetary expansion. And perhaps — just perhaps — the Japanese were afraid that a reduced rate of monetary expansion in the US would make it more difficult for the Japan to continue its own program of monetary expansion, because a reduced rate of US monetary expansion, with no change in the rate of Japanese monetary expansion, would lead to US pressure on Japan to prevent further depreciation of the yen against the dollar, or even pressure to reverse the yen depreciation of the last six months. Well, if that’s the case, I would guess that the Japanese would view their ability to engage in monetary expansion as being constrained by the willingness of the US to tolerate yen depreciation, a willingness that in turn would depend on the stance of US monetary policy.
The highlighted segment in the paragraph above has correspondence to what happened in the early 1980s when the ‘US would not allow’ the yen to depreciate. And is also consistent with David Beckworths view of US supermonetary power status.