In the years after the 2008 financial crisis, as the US Federal Reserve battled to bring down unemployment, Ben Bernanke, its then chairman, was often urged to consider a couple of radical ideas.
One was that the Fed should promise to overshoot its 2 per cent inflation target. Another was that it should effectively make its bond purchases unlimited, putting caps on yields and promising to buy all bonds offered at that price.
Mr Bernanke was not convinced by either proposal but now Haruhiko Kuroda, governor of the Bank of Japan, has adopted both policies in a single day. JPMorgan chief economist Masaaki Kanno calls it “the biggest regime shift since Kuroda became governor”.
But the danger is that Mr Kuroda has left his move too late and the BoJ no longer has enough credibility to make promises — leaving him with all the downside from radical policy action but little of the benefit.
A yield cap could ease policy in theory because, if and when inflation in Japan picks up, the interest rates paid by businesses and homeowners will not follow them upwards.
“Under the previous strategy of asset purchase targets, a rise in inflation would have been expected to be matched by a firming of JGB yields, keeping real yields broadly stable,” says Simon Ward, chief economist at Henderson Global Investors.
“The new peg at zero will force real yields lower as inflation picks up — policy, in other words, will become more expansionary as inflation rises towards the target.”
The problem for the BoJ is a widespread perception that it is targeting yields because it has run out of bonds to buy, and rather than easing, the change is actually an admission that it will be hard for the BoJ to hit its inflation goal.
“This change in the policy framework shifts the focus from quantitative measures to interest rates,” said Kiichi Murashima at Citi in Tokyo. “One way of interpreting this decision is an effective retreat by the BoJ from a ‘short war’ to achieve its 2 per cent target.”
Although the BoJ said it would continue to buy government bonds at a pace of about ¥80tn a year, it will no longer buy as much long-term debt, letting yields on those bonds rise so banks can make money. That adds to the perception of a retreat.
The second part of the policy, pledging to overshoot its 2 per cent goal, also eases policy in theory by encouraging the public to expect higher inflation in the future. If inflation is expected to be high, borrowing at today’s low rates looks a better deal.
But a promise to overshoot only matters if the public believes it will actually happen, and as Mr Kanno says, the last three-and-a-half years of stuttering efforts to raise inflation mean that “the BoJ’s credibility is down tremendously”.
“Few people believe that 2 per cent inflation will be achieved any time soon without new tools,” he says, but the commitment to overshoot “will work only if and when people believe 2 per cent inflation is on the horizon”.
Market reaction suggests investors do not think the BoJ’s promises are credible. After initially weakening by about 1 per cent against the dollar, the yen rallied a few hours later, and by the end of Tokyo trading it was up a little on the day.
That means Mr Kuroda may get the worst of all worlds: little easing benefit now, but big problems if and when inflation does start to rise, because the yield cap and his pledge to overshoot 2 per cent will make his exit from easy policy — already challenging — even harder to manage.