Kuroda's policies as Governor of the Bank of Japan (Summarised)

Kuroda's policies as Governor of the Bank of Japan during his full tenure

Haruhiko Kuroda served as the Governor of the Bank of Japan (BOJ) from 2013 to 2021. During his tenure, he implemented a monetary policy known as "Quantitative and Qualitative Monetary Easing (QQE)," which aimed to achieve the BOJ's 2% inflation target.

Under Kuroda's leadership, the BOJ pursued an aggressive monetary easing policy that involved massive purchases of Japanese government bonds, exchange-traded funds (ETFs), and real estate investment trusts (REITs) to inject liquidity into the economy and stimulate inflation. Kuroda also introduced negative interest rates to encourage banks to lend more and stimulate economic growth.

Despite these efforts, Japan struggled to achieve its inflation target, and Kuroda faced criticism for his policy's effectiveness. However, he maintained his commitment to the QQE policy throughout his tenure, citing the need to maintain a stable financial system and support economic growth.

The dates when policy was changed or implemented

Here are some of the key dates when Haruhiko Kuroda implemented or changed monetary policy during his tenure as Governor of the Bank of Japan:

March 14, 2013: Kuroda is appointed as Governor of the Bank of Japan, and introduces "Quantitative and Qualitative Monetary Easing (QQE)" as the central bank's primary monetary policy tool.

April 4, 2013: The BOJ announces its QQE policy, which includes a plan to purchase ¥50 trillion ($472 billion) of Japanese government bonds annually.

October 31, 2014: The BOJ expands its QQE policy, increasing its annual purchases of government bonds to ¥80 trillion ($729 billion).

January 29, 2016: The BOJ introduces negative interest rates, lowering its policy rate to -0.1%.

September 21, 2016: The BOJ announces a new policy framework called "Quantitative and Qualitative Monetary Easing with Yield Curve Control (QQEY)," which aims to keep the yield on 10-year Japanese government bonds at around 0%.

July 31, 2018: The BOJ makes minor changes to its QQEY policy, allowing for greater flexibility in its bond purchases.

March 15, 2021: Kuroda announces that he will step down as Governor of the Bank of Japan in April 2021, after serving for eight years.

At one stage the Central Bank of Japan became the biggest owner of Japanese equity

Yes, it is true that at one stage the Bank of Japan (BOJ) became the largest owner of Japanese equities.

Under Haruhiko Kuroda's leadership, the BOJ's quantitative easing policies involved not only purchasing massive amounts of Japanese government bonds, but also buying Japanese stocks through exchange-traded funds (ETFs). The BOJ's ETF purchases were aimed at increasing liquidity in the stock market, stimulating economic growth, and achieving its inflation target.

By September 2016, the BOJ's ETF holdings exceeded ¥20 trillion (approximately $186 billion), making it the largest shareholder in many major Japanese companies, including Toyota, Sony, and Fast Retailing (owner of the Uniqlo brand). At the time, the BOJ's holdings represented around 4% of the total market capitalization of the Tokyo Stock Exchange's first section.

While the BOJ's equity purchases have been controversial, Kuroda defended them as necessary to achieve the bank's monetary policy goals and maintain financial stability. However, some critics have raised concerns about the potential distortion of market forces and the risk of the BOJ becoming too influential in the Japanese economy.

What did Kuroda's policies aim to achieve?

Haruhiko Kuroda, during his tenure as the Governor of the Bank of Japan, implemented monetary policies aimed at achieving two main goals: stimulating economic growth and achieving the bank's inflation target of 2%.

To achieve these goals, Kuroda implemented a monetary policy known as "Quantitative and Qualitative Monetary Easing (QQE)." This policy involved the BOJ purchasing massive amounts of Japanese government bonds, exchange-traded funds (ETFs), and real estate investment trusts (REITs) to inject liquidity into the economy and stimulate inflation. Kuroda also introduced negative interest rates to encourage banks to lend more and stimulate economic growth.

The goal of this policy was to create an environment where firms and households were more willing to spend and invest, thereby boosting economic activity and achieving the 2% inflation target. Kuroda believed that by using these measures to increase liquidity and lower borrowing costs, the BOJ could stimulate demand and help support economic growth.

Were these objectives achieved and why?

During Haruhiko Kuroda's tenure as Governor of the Bank of Japan (BOJ), the bank's efforts to achieve its inflation target of 2% and stimulate economic growth through its monetary policy were largely unsuccessful.

Despite implementing aggressive monetary easing policies such as Quantitative and Qualitative Monetary Easing (QQE), the BOJ struggled to achieve its inflation target. Inflation remained persistently low, averaging around 0.5% annually during Kuroda's tenure. This was due to various factors such as an aging population, weak consumer demand, and global economic uncertainty.

The BOJ's policy of purchasing exchange-traded funds (ETFs) and real estate investment trusts (REITs) also made the bank the largest shareholder in many major Japanese companies. While this policy helped to support the stock market and boost corporate profits, it did not translate into higher wages or increased consumer spending, which would have supported economic growth.

Despite these challenges, some analysts argue that the BOJ's monetary policies helped to stabilize the economy and prevent deflation. The BOJ's policies kept borrowing costs low, which helped support consumer spending and investment. The policies also helped to weaken the yen, which supported Japan's export-driven economy.

In summary, while the BOJ's efforts to achieve its inflation target and stimulate economic growth were largely unsuccessful during Kuroda's tenure, the bank's policies may have helped to prevent a more severe economic downturn and stabilize the economy.

How did Kuroda's policy impact the wage earners in Japan?

Haruhiko Kuroda's monetary policy during his tenure as Governor of the Bank of Japan (BOJ) had a mixed impact on wage earners in Japan.

On the one hand, Kuroda's policy of aggressive monetary easing, including purchasing massive amounts of Japanese government bonds, was intended to stimulate economic growth and increase inflation, which in turn would lead to higher wages. However, despite these efforts, wage growth in Japan remained sluggish during Kuroda's tenure.

One factor that contributed to the lack of wage growth was the slow pace of structural reforms in Japan, which Kuroda had limited control over. Additionally, many Japanese companies remained hesitant to raise wages even as corporate profits increased, due to concerns about the uncertain economic outlook and the need to maintain competitiveness.

On the other hand, Kuroda's policy of purchasing exchange-traded funds (ETFs) and real estate investment trusts (REITs) helped support the stock market, which in turn benefited wage earners who held stocks or stock-based retirement savings plans. The policy also helped support corporate profits, which could potentially lead to increased hiring and wage growth in the future.

Overall, while Kuroda's monetary policy had limited success in boosting wage growth in Japan, it may have indirectly benefited wage earners through its support of the stock market and corporate profits. However, the impact on wage earners was mixed and ultimately limited by structural challenges in the Japanese economy.

How has Kuroda's policy impacted the savers?

Haruhiko Kuroda's monetary policy during his tenure as Governor of the Bank of Japan (BOJ) had a mixed impact on savers in Japan.

On the one hand, Kuroda's policy of aggressive monetary easing, including keeping interest rates low and purchasing massive amounts of Japanese government bonds, had a negative impact on savers. These policies meant that interest rates on savings accounts and government bonds remained low, providing savers with little to no return on their investments.

On the other hand, Kuroda's policy of purchasing exchange-traded funds (ETFs) and real estate investment trusts (REITs) helped support the stock market, which in turn benefited savers who held stocks or stock-based retirement savings plans. Additionally, the policy of negative interest rates was intended to stimulate economic growth, which could potentially lead to higher returns on other types of investments.

Overall, Kuroda's monetary policy had a negative impact on savers who relied on traditional savings accounts or government bonds for their investments. However, savers who held stocks or stock-based retirement savings plans may have indirectly benefited from the policy's support of the stock market.

The Japan stock market from 1970s to now

The Japanese stock market, also known as the Nikkei, has experienced significant ups and downs since the 1970s. Here is a brief overview of its history:

1970s: The Japanese economy experienced rapid growth during this decade, and the Nikkei reached its peak in 1973, closing at 6,251.12. However, the market suffered a significant downturn in 1974 due to the oil crisis, with the Nikkei dropping to 3,251.83.

1980s: This decade saw the Japanese stock market experience unprecedented growth, with the Nikkei hitting a peak of 38,915.87 in 1989. This period of rapid expansion is often referred to as the "bubble economy" due to the inflated stock and real estate prices.

1990s: The bubble economy eventually burst in the early 1990s, leading to a prolonged period of economic stagnation in Japan known as the "Lost Decade." The Nikkei suffered significant losses, dropping below 10,000 in 1992 and remaining below that level for most of the decade.

2000s: The Nikkei gradually recovered in the 2000s, although it still experienced significant volatility. The market reached a high of 18,138.04 in 2007, but this was followed by a sharp decline during the global financial crisis in 2008.

2010s: The Nikkei continued to recover in the 2010s, reaching a high of 24,448.07 in 2018. However, the market also experienced significant fluctuations due to factors such as the earthquake and tsunami in 2011 and geopolitical tensions.

2020s: In 2020, the Nikkei, like most global stock markets, experienced a significant downturn due to the COVID-19 pandemic. However, it has since recovered and has been trading at relatively stable levels in 2021 and 2022.

Fighting excessive deflation once interest rates have been reduced to zero

Fighting excessive deflation is in some ways more difficult than fighting hyperinflation.

During inflationary times, there is basically no limit to how much central banks can raise interest rates.

But in the battle against deflation, once interest rates have been reduced to zero, there is little that central banks can do to stimulate further growth.  

The two things that can be done once interest rates reach zero are:

• negative interest rates or 
• quantitative easing.

Quantitative easing: how is this done?

Central banks use quantitative easing to create money

Faced with the economic meltdown following the 2008 crash, some central banks opted to stimulate their moribund economies via quantitative easing.

Quantitative easing uses the unlimited purchasing power of central banks to buy large quantities of bonds in the open market to pump cash into the economy.  

Central banks use quantitative easing to create money where previously none existed.

How is this done?

A central bank "creates" money every time it dips into its "vaults" - essentially a black hole of unlimited financial resources - to buy existing bond from banks or other investors.

These purchases, often referred to as open market operations, inject new money into the economy.  

The bank, instead of holding bonds, is now holding the "cash" it got from the central bank.  

This money can now be made available for loans to consumers and individuals, thereby stimulating economic growth.

Unconventional Monetary Policy: Exit Strategy (1)

EXIT STRATEGY

How and when do central banks need to unwind the extra monetary stimulus? 

Simple answers:

• when the economy rebounds and 
• inflationary prospects are back in line with the central bank’s price stability objective. 

Not Easy

Unfortunately, for a number of reasons, formulating an adequate exit strategy is not such an easy task. Why? 

Two choices that need to be made: 

• first, devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; 
• second, deciding on the speed at which the unconventional accommodation is removed.

To unwind unconventional monetary policy operations (in the case of quantitative easing and credit easing policies), 

• it normally implies selling assets outright, and in significant amounts. 

In the case of the endogenous easing measures, the unwinding happens automatically, since banks should naturally 

• reduce their demand for central bank money and 
• increase interbank lending as their situation normalises.

Reference:

https://www.ecb.europa.eu/press/key/date/2009/html/sp090428.en.html?fbclid=IwAR3l-HERTcR1afdIISMWCe0owxInfKY2zF5O5L4E-pfpADWdhAt4W6Z-Ux0

Conventional and unconventional monetary policy
Lorenzo Bini Smaghi,
Member of the Executive Board of the European Central Bank,
Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),

GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

Unconventional Monetary Policy: Conclusion (8)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

Conclusions

To conclude, the decision whether to embark on non-conventional monetary policy measures, which specific ones and for how long depends on a series of considerations, including

• the overall conditions of the economy, in particular the presence of deflationary pressures and 
• the effective constraint provided by the zero lower bound for interest rates, 
• the structure of the financial flows in the economy, 
• the medium term incentives that would be created for the private sector and 
• the risks entailed in the exit strategy, including for the independence and credibility of the central bank. 

Some measures present greater advantages, in terms of providing the right incentives and being easily reversible. 

Others present more risks and have to be well targeted and used under specific circumstances. 

Considering the pros and cons of the various measures requires deep thinking. 

I have tried to develop tonight some of the considerations underlying such a reflection.

Hopefully this has been useful in understanding why the ECB has proceeded speedily in some areas while taking the necessary time to reflect on others.

Thank you very much for your attention.

https://www.ecb.europa.eu/press/key/date/2009/html/sp090428.en.html?fbclid=IwAR3l-HERTcR1afdIISMWCe0owxInfKY2zF5O5L4E-pfpADWdhAt4W6Z-Ux0

Conventional and unconventional monetary policy
Lorenzo Bini Smaghi,
Member of the Executive Board of the European Central Bank,
Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

Unconventional Monetary Policy: Exit Strategy (7)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

Exit strategy

Let me now turn to the last of the four questions that I posed earlier on: how and when do central banks need to unwind the extra monetary stimulus? The simple answer to this question would be – of course – when the economy rebounds and inflationary prospects are back in line with the central bank’s price stability objective. Unfortunately, for a number of reasons, formulating an adequate exit strategy is not such an easy task. Why? Let me mention two choices that need to be made: first, devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; second, deciding on the speed at which the unconventional accommodation is removed.

Let me first clarify what it means, in practice, to unwind unconventional monetary policy operations. In the case of quantitative easing and credit easing policies, it normally implies selling assets outright, and in significant amounts. In the case of the endogenous easing measures, the unwinding happens automatically, since banks should naturally reduce their demand for central bank money and increase interbank lending as their situation normalises.

Starting with the problem of the right sequence, it should be reminded that an environment of extremely low interest rates and ample liquidity aims at favouring borrowers and penalising lenders, over the medium term, when the policy is reversed. On the other hand, most of the unconventional measures put in place are designed to stimulate lending, to convince savers to hold risky longer-term assets. The effectiveness of these measures therefore mainly depends on the readiness of banks to go back to their main business of lending to households and firms rather than parking excess reserves with the central bank. Clearly, an increase in policy rates – and in particular in the deposit rate – risks undermining banks’ incentive to re-engage in funding the private sector. In a similar vein, prospects of rising interest rates may discourage private savers from purchasing longer-term assets, as a tightening of monetary policy inevitably implies a capital loss for those who bought these assets. Raising policy rates, or the expectation of such increases, when confidence is not fully restored could therefore be counterproductive.

What, then, are the implications for the sequencing of unwinding conventional and unconventional policy measures? In simple terms, it means that non-standard measures that aim mainly at restoring the orderly functioning of money markets, such as supplementary longer-term refinancing operations or an extended menu of eligible collaterals, might have to be rolled back before interest rates are increased again. Why?

First of all, because raising interest rates in an environment in which such unconventional measures were still judged to be necessary would risk undermining a sustained recovery by money markets. If concerns about the required and available amounts of short-term funding still prevailed among market participants, raising rates might reinforce these fears and could lead to further, unwarranted upward pressure on overnight rates. Second, supplying extra liquidity to the markets through non-standard measures while, at the same time, tightening monetary policy would send mixed signals on the effective monetary policy stance. Measures to alleviate the strains in money markets could in fact be seen as a continued easing of the monetary policy stance. Third, with non-standard measures such as the unlimited provision of liquidity still in place it might be more difficult for the central bank to steer the level of market rates consistent with its policy target. For example, a fixed rate tender with full allotment usually leaves the banking sector with a large daily liquidity surplus, which needs to be mopped up by additional fine-tuning operations towards the end of the reserve maintenance period in order to avoid a sharp drop in the overnight interest rate. This, however, causes extra volatility in the markets as well as large interest rate fluctuations that are undesirable from the point of view of an effective signalling of the monetary policy stance. Fourth, with markets still in need of additional non-standard measures, the pass-through of an increase in policy rates would probably be hampered. The orderly transmission of any monetary tightening would only resume once trust among market participants has had been restored and money markets were operating normally again. Finally, in any bank-dominated system of fund intermediation, in which the recovery of the economy largely depends on the soundness of the banking system, inflationary pressures that would require a tightening of monetary policy are likely to appear only when the banks take up their normal lending activity again. This, in turn, implies that non-standard measures should ideally be rolled back before interest rates were increased.

This reasoning might not hold for measures taken to revitalise the flow of credit in certain market segments – such as through the purchase of corporate bonds. These measures are primarily designed to bypass the financial sector and to ensure that non-financial corporations still have access to external financing. Now, in theory, by stimulating longer-term investments and hence aggregate demand, these measures might induce inflationary pressures in the medium to long-term, independent of the functioning of money markets and lending by banks. The strength of this channel depends on the depth of the corporate bond market. If policy-makers were to react to these inflationary pressures by raising interest rates pre-emptively while money markets were still weak, the consequences for the banking channel of intermediation could be severe – for the reasons I have just given. If, however, markets were to function properly again, there would be no reason to postpone the unwinding of ‘credit easing’ policies to a date longer than needed. Taken together, this reasoning suggests that purchases of privately issued securities should be unwound before or at the same time as interest rates are raised back to normal levels.

This raises the question of the reaction that financial markets might have to the start of the unwinding of the direct easing measures. For instance how would markets react to the central bank starting to sell the government bonds it purchased under the direct quantitative easing policy? Such a start would signal presumably that the tightening cycle is close and could affect yields. Furthermore, if the amount of assets to be sold is significant, this can have an impact on the market conditions of the underlying assets, possibly further depressing its price.

Naturally, the question remains: how quickly should policy-makers reverse their policies? On the one hand, withdrawing liquidity in such large quantities will trigger a substantial contractionary monetary policy shock. The large size of many easing programmes will make it difficult to sell assets without a significant market impact. If it happens too quickly or abruptly, policy-makers risk choking off the economic recovery or imposing heavy capital losses on lenders. For instance, in the corporate bond or commercial paper market, even small sales of securities by the central bank could cause spreads to widen considerably and to sharply tighten credit conditions for firms. On the other hand, with policy rates at record low levels and additional liquidity-providing measures adopted in so many countries, the possibility of inflation risks emerging sometime later is not something that can be excluded. Retaining such exceptional policy measures for too long might aggravate the upside risks to price stability and sow the seeds for future imbalances in financial markets.

Getting the timing right in withdrawing additional liquidity is likely to be decisive in order to ensure a non-inflationary recovery. Generally speaking, the lower the reversibility of the non-conventional operations, the larger the risk of being behind the curve when the macroeconomic and financial market situation improves.

Indeed, to a large extent the speed of unwinding of unconventional measures would depend on their degree of reversibility. As I already noted, some of the unwinding would happen automatically as central bank programmes become increasingly unattractive as financial conditions normalise. For instance, many lending facilities provide liquidity at a premium over the main policy rate or with a high haircut applied to the required collateral, making interbank lending the more attractive option once normal lending activity among market participants is restored. As a result, the central bank’s balance sheet would decline automatically as demand for its funds decreases. As noted, the ECB’s current liquidity-providing operations imply an ‘endogenous’ exit strategy as banks would automatically seek less credit from the ECB when tensions in financial markets ease. The speed of the reversibility would therefore largely depend on the speed of the resurgence of the financial system. In the euro area, the revitalisation of money markets is key to the ECB’s exit strategy and any future interest rate decision should therefore avoid a further disruption of money markets. In this context, bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending. This, in turn, could blur the important signals coming otherwise from the resurgence of interbank lending and the associated positive effect on the ECB’s balance sheet.

Obviously, the speed of tightening would also depend on the maturity of the assets bought by central banks within the framework of their easing programmes. Differences in the maturity of assets will ensure that a tightening of the accommodative stance would come in gradual tranches. This is important to avoid any abrupt tightening of credit conditions in the middle of the recovery. At the same time, measures centered on assets that are longer-term in nature and less liquid could pose challenges to the future unwinding of these measures. If market conditions were to improve faster than expected, an increase in the average maturity of the central bank’s portfolio would make it more difficult for financial markets to return to normal private sector functioning and would also heighten medium-term inflation risks.

Overall, special operations other than the traditional repurchase agreements might be needed to sterilise the effects of unconventional policy measures at the appropriate time in the future. One option would be to have the fiscal authority issue debt certificates to the market and deposit the proceeds with the central bank. The switch in the ownership of government debt from the private sector to the monetary authority would alleviate the inflationary pressures arising from the additional liquidity. Another option would be for the central bank to issue debt certificates itself, as the ECB for example can do according to its Statute. In this way the central bank would essentially change the composition of the liabilities side of its balance sheet, moving away from excess reserves and towards less-liquid debt securities. The effect, compared with government debt issuance, would in essence be the same.

An important final element related to the exit strategy, but which should be considered carefully already when deciding to embark on unconventional measures, is that when the central bank sells the assets their value is likely to have declined considerably, given the higher rate of interest. This implies a financial loss for the central bank. The consequences for the financial – and overall – independence of the central bank should not be downplayed.

Unconventional Monetary Policy: Indirect (or Endogenous) Quantitative/Credit Easing (6)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

The measures described above foresee the direct acquisition by the central bank of the assets, in exchange for central bank money. This implies that the central bank directly holds the assets, until maturity or resale, and thus the risk on its balance sheet. An alternative way is to increase the size of the balance sheet by lending to banks at longer maturities, against collateral which includes assets whose markets are temporarily impaired. This policy affects directly the yield curve over the horizon at which policy operations are conducted or committed to be conducted. For instance, monetary policy operations with maturity of 6 months directly affect the 6 months interbank money market. This is particularly the case if the operations are conducted at a fixed rate, full allotment. The horizon of the yield curve which is affected may be lengthened to the extent that the central bank commits to conduct such type of tenders for a given period of time. For instance, if the central bank commits to conduct 6 months refinancing operations with fixed rate tenders for 2 years, the yield curve over the two and a half year horizon is likely to be influenced.

The increase in the monetary base is determined endogenously by the banking system, based on banks’ preference for liquidity and thus on the state of stress of the banking system. In normal conditions, when financial markets function properly, the size of the central bank balance sheet would be such that the overnight rate would coincide with the short term refinancing rate of the central bank and excess reserves are negligible. Under stress, the size of the central bank balance sheet would increase, on the basis of banks’ increased demand for excess reserves, to the point that the overnight rate would be lower than the short term main refinancing rate.

Another aspect of such a policy relates to the quality of the collateral. By enlarging the pool of the collateral accepted for the refinancing operations with the central bank, the financing conditions by banks to these sectors are facilitated, which should be reflected in the credit spreads that banks charge in particular to the corporate sector. This technique also enables the counterparties of the central bank to choose the collateral to use in their refinancing operations. In times of market stress there will be a natural tendency for banks to use a greater amount of assets of a lower quality. The overall collateral deposited with the central bank will vary endogenously, depending on the state of stress of the financial markets. The eligibility of certain categories of assets for monetary policy operations will facilitate their creation and trade among market participants.

In the euro area, the ECB decided to adopt a ‘fixed-rate full-allotment’ procedure: since October 2008 eligible counterparties in the euro area have had access to unlimited liquidity for periods ranging from one week up to six months at a fixed rate. At the same time, we implicitly eased monetary conditions further by expanding the list of assets eligible as collateral in Eurosystem refinancing operations. The Eurosystem accepts a broad range of assets as collateral in all its credit operations. This feature of the Eurosystem’s collateral framework, together with the fact that access to Eurosystem open market operations is granted to a large pool of counterparties, has been key to supporting the implementation of monetary policy in times of stress. The in-built flexibility of its operational framework allowed the Eurosystem to provide the necessary liquidity to address the impaired functioning of the money market without encountering widespread collateral constraints throughout much of 2008. It was only towards the end of the year that, in the light of the extension of refinancing for terms longer than overnight in euro and in US dollars as well as the recourse to fixed rate full allotment tender procedures, the Governing Council decided to expand the list of eligible collateral on a temporary basis until the end of 2009.

In 2008 the average amount of eligible collateral increased by 17.2%, compared with 2007, to a total of €11.1 trillion. As regards the composition of collateral put forward, the average share of asset-backed securities increased from 16% in 2007 to 28% in 2008, overtaking uncovered bank bonds as the largest class of assets put forward as collateral with the Eurosystem. Uncovered bank bonds accounted on average for slightly less than 28% of the collateral put forward in 2008. The average share of non-marketable assets increased from 10% in 2007 to 12% in 2008. By contrast, the average share of central government bonds dropped from 15% in 2007 to 10% in 2008.

In my opinion, these changes to our monetary policy implementation can be better characterised as ‘endogenous credit easing’ rather than ‘quantitative easing’, since the main aim is to relax banks' collateral and funding liquidity constraints, so that they will expand credit supply. Moreover, it is a policy that has been implemented at above-zero level of the short term nominal interest rates.

It should also be emphasised that, given the importance of the banking channel in providing credit to the economy, the unconventional policy measures that would best suit the euro area are likely to differ in terms of scope and depth from those in the US or other advanced economies where a more market-based financial system prevails, a consideration that is too often overlooked. This is the main reason why our policy response so far has been tailored to the specific nature of Europe’s financial structure. A few figures will give an idea of the differences in the financial systems of the US and the euro area. For example, at the end of 2007, the stock of outstanding bank loans to the private sector amounted to around 145% of GDP in the euro area, but only to 63% in the United States. By contrast, outstanding debt securities – a measure of the depth of financial markets – amounted to 81% of GDP in the euro area as against 168% in the United States.

The ECB operations have eased financing conditions for the private sector and allowed banks to refinance loans more easily than would otherwise have been the case. The evidence on the extent of these policy measures on market interest rates and money market conditions is quite encouraging. While the spread between the three-month Euribor and the EONIA is now at levels well below 100 basis points as well as at comparable levels or below the corresponding spreads seen in the US and the UK, ECB refinancing operations are also down from a peak of €857 billion at the beginning of the year to 676 billion last Friday. There is also mounting evidence that the Eurosystem’s policy measures have been effective in averting a dramatic contraction in credit volumes, though credit developments certainly need a close monitoring in the period ahead.

Unconventional Monetary Policy: Direct Credit Easing (5)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

How are unconventional measures implemented?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

2 Direct Credit Easing

Credit easing is a policy that directly addresses liquidity shortages and spreads in certain (wholesale) market segments through the purchase of commercial paper, corporate bonds and asset-backed securities. The effectiveness of measures which are aimed at wholesale financial markets depends on their importance in the financing of households and firms, which varies considerably from country to country. (It is notably lower in the euro area than in the US, for example). It is also a more attractive strategy in times of acute bank distress, for obvious reasons.

Two things need to be noted here. First, buying privately issued securities is not fundamentally different from buying government bonds in terms of the impact on the money supply or the monetary base. Second, buying privately issued securities implies that the central bank interacts directly with the private sector and is thus stepping into the realm of credit risk – just as any normal commercial bank would do. Outright purchases of privately issued securities affect the risk profile of the central bank’s balance sheet. In order not to compromise the financial independence of the central bank, policy-makers need to carefully assess the eligibility of all assets on account of the implications they could have for the risk exposure of the central bank’s balance sheet.

Caution is also called for in another respect. Outright purchases of privately issued securities need to be carefully planned to avoid allocative distortions in terms of industries, firms or regions. Also the size of the issuer matters. While it is easy to see how large firms can benefit from the central bank’s purchases of privately issued securities, it is more difficult to ensure that small and medium-sized companies get equal treatment. Given the limited depth of corporate bond markets in many economies, purchases of privately issued securities might therefore be a difficult endeavour for policy-makers.

The Federal Reserve’s approach since December 2007 has been a high-profile example of credit easing. The Fed has established several lending programmes to provide liquidity and improve the functioning of key credit markets. The Term Auction Facility, for instance, helps to ensure that financial institutions have adequate access to short-term credit, while the Commercial Paper Funding Facility provides a backstop for the market for high-quality commercial paper.   More recently, the Fed, in cooperation with the US Treasury Department, has begun to purchase asset-backed securities such as mortgage securities backed by government-sponsored enterprises (GSEs).

How effective have these measures been? It’s too early to say. Moreover, with a wide range of unconventional monetary policy measures – since March the Fed has also been purchasing government bonds in parallel – it is extremely difficult to single out the impact of any specific measure. That being said, the spreads on eligible commercial paper in the United States have come down following the introduction of the Fed’s Commercial Paper Funding Facility (see Chart 1). Also, the Fed’s purchases of GSE debt and GSE-guaranteed mortgage-backed securities have resulted in a decline of the 30-year conforming mortgage rates by more than one percentage point following the announcement of this programme in late November 2008, and have continued to decline since its expansion on 18 March 2009 (see Chart 2). The narrowing of the spread between mortgage rates and Treasuries also suggests that the Fed’s programme of purchasing agency-related mortgage securities may have been effective in easing mortgage market conditions.

Unconventional Monetary Policy: Direct Quantitative Easing (4)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

How are unconventional measures implemented?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing

1 Direct Quantitative Easing

When the central bank decides to expand the size of its balance sheet, it has to choose which assets to buy. In theory, it could purchase any asset from anybody. In practice, however, quantitative easing has traditionally focused on buying longer-term government bonds from banks. The idea is twofold: first, sovereign yields serve as a benchmark for pricing riskier privately issued securities. When long-term government bonds are purchased, the yields on privately issued securities are expected to decline in parallel with those on government bonds. Second, if long-term interest rates were to fall, this would stimulate longer-term investments and hence aggregate demand, thereby supporting price stability.

This is where banks play a critical role in the success of any quantitative easing policy. If the aim is to ensure that new loans are provided to the private sector, central banks should mainly purchase bonds from the banks. The additional liquidity would then be used by the banks to extend new credit. However, banks may choose to hold the liquidity received in exchange for the bonds in their reserves at the central bank as a buffer. In this case, the liquidity provided by the central bank remains within the financial sector; it does not flow out of it. This risk can be minimised if the central bank conducts this type of operation only at the lower bound – that is, when it has fully exploited the standard interest rate channel. At the lower bound the remuneration of deposits is null (or almost null) and there is hence little or no incentive for banks to park excess reserves with the central bank. Deploying a policy of quantitative easing at a policy rate different from the lower bound may necessitate a larger expansion of the central bank’s balance sheet and thus increase the risk exposure of the monetary authority.

In light of the above considerations, the soundness of the financial system is critical to the success of quantitative easing. When banks stop intermediating loans, this policy no longer works. Quantitative easing is successful if it narrows the market spreads between the rates paid on selected credit instruments and policy rates, thereby limiting the risks of a liquidity shortfall and encouraging banks to extend credit to higher interest-paying parties.

The Bank of Japan’s policy between 2001 and 2006 provides one example of quantitative easing. It had the following key features: first, it involved a shift in the operational target for money market operations from the uncollateralised overnight call rate to the outstanding balance of current account deposits at the Bank of Japan, or in short the bank reserves; second, it entailed outright purchases of Japanese government bonds to meet the target balance of current account deposits at the Bank; and third, it involved an explicit, public commitment to maintain these open market operations until the CPI did not fall on a sustainable basis.

During that period, the Bank of Japan had discussions with academics about strategies for avoiding prolonged deflation. These talks repeatedly gave rise to one particular question: why didn’t the Bank of Japan simply allow the yen to depreciate in order to stop the fall in consumer prices? This is the essence of Lars Svensson’s prominent suggestion of ‘The Foolproof Way’ out of deflation.  But if it were so simple, why did the Japanese authorities apparently fail to take the necessary measures to prevent deflation? The answer is: it wasn’t that simple. What ‘The Foolproof Way’ underestimates is the enormous difficulty of turning around expectations of prices and economic activity when the functioning of the financial system is seriously impaired. The failures to restructure Japan’s financial and corporate sector and to recapitalise banks have been widely documented as key reasons for the country’s anaemic growth rates and declining prices  – factors over which the Bank of Japan had little control.

Let me just add something on that matter: ‘The Foolproof Way’ wouldn’t work in today’s context either. Given the global dimension of the current financial crisis, it would not be possible for all countries to depreciate their currencies at the same time in order to push inflation up. Such a beggar-thy-neighbour policy would be ineffective in the present circumstances; worse, it would aggravate them by unleashing a protectionist backlash. In fact, the leaders of the G20 recently agreed to refrain from competitive devaluation of their currencies, and it is important to stick to this objective in both words and deeds. Although not all countries belong to the G20, I am confident that all advanced economies will comply with this principle.

There are some important lessons we can learn from the experience of quantitative easing in Japan:

• To begin with, it cannot be taken for granted that an increase in the monetary base results in easier monetary conditions. In fact, the money multiplier has significantly decreased during the last decade. This has, to a certain extent, reduced the effect of injecting money into the economy. 
• Second, as mentioned before, the banking system is crucial for the success of a quantitative easing policy.  However, given the high degree of de-leveraging which the Japanese economy, and the banking sector in particular, was undergoing, banks did not find themselves in a position to pass on the additional liquidity to the non-financial sector.
• Third, one of the expected effects of quantitative easing is a flattening of the yield curve at longer maturity which improves the medium to longer-term financing conditions for the private sector. But what ultimately matters for investment and spending decisions is the real interest rate and hence inflation expectations. Strictly speaking, an increase in the money supply should have implications for the expectations of the future price level. But quantitative easing will only affect expected inflation if the increase in the size of the central bank’s balance sheet is not only sizeable but also perceived as being permanent.  The experience of the Bank of Japan provides a clear-cut example of a temporary expansion of the monetary base that did not affect private sector inflation expectations.
• Fourth, it is not clear how it is possible to increase inflation expectations in a significant way while avoiding a rise in the nominal long-term interest rate after some time. Setting the real long-term interest rate as the operational target for monetary policy seems to be rather challenging in an environment with developed financial markets.
• Fifth, if quantitative easing is perceived as being long-lasting then it could also have an expansionary effect by relaxing fiscal constraints. Expansionary fiscal policies represent a sound instrument to stimulate aggregate demand during a deflationary period. In this respect, outright purchases of government bonds by the monetary authority could further strengthen fiscal effects i) by accommodating the supply of governments bonds, ii) by affecting the long-end of the yield curve - the risk premium - and iii) by re-anchoring inflation expectations to a positive target. In particular, the transition to a positive inflation regime reduces the burden on the future fiscal budget by guaranteeing its financial sustainability.  Of course, the relevance of this effect crucially depends on the duration of the quantitative easing policy and on a credible commitment to a well-defined exit strategy. In this respect, the broad effects stemming from the fiscal and monetary policy mix have been quite muted in stimulating the Japanese economy.
• Finally, it should be recognised that a government bond purchasing programme involves the risk of accumulating significant losses for the central bank. Government bonds would be purchased at rather high prices. If the easing measure turned out to be a success, the ensuing economic recovery would gradually entail an increase in long-term interest rates; this would bring down government bond prices, so that the central bank would eventually face losses. Concerns about central bank’s balance sheet and financial independence can seriously impede monetary policy.  Such constraints may be one reason why the Bank of Japan’s government bond purchasing programme has failed to restore positive inflation rates.

Let me also mention that in the context of the euro area the design of such unconventional policy measures poses some intricate challenges, due to its unique institutional framework. In the first place, we need to be mindful of the Treaty requirements relating to the prohibition of monetary financing and the granting of privileged access, as well as of the consistency with the Treaty principle of open market economy and the preservation of the disciplining function of markets for borrowers and lenders.  Although purchases of government bonds are possible in the secondary market, there is a risk to eventually become a market maker for public debt, which could be construed to be against the Treaty prohibition of monetary financing. Moreover, we have more than just one fiscal authority in the euro area. The Eurosystem would have to decide how to spread purchases of government bonds across euro area countries. If, for example, the Eurosystem only concentrated on public bonds with the best credit rating, it would risk providing privileged access to some countries, contravening Article 102 of the Treaty. If it spread purchases according to a specific key and ended up affecting cross-country differences in yields, it would be seen as granting privileged access, as financing conditions for some governments would be supported to a greater extent than for others. It may also be the case that the risk-free component of corporate bonds would not move exactly in tandem with the risk-free component of government bond yields. This would be tantamount to giving preferential treatment to government debt. These issues would need to be addressed before implementing a government bond purchasing programme in the euro area.