Japanese Monetary Policy Is Working, But the BoJ Can’t Tell You Why

In September 2016, the Bank of Japan adopted a new strategy to boost the flagging Japanese economy: “yield curve control,” or YCC. The aim was to widen the gap between long- and short-term interest rates, by keeping shorter-term (10-year) government bond (JGB) rates at 0%, as a means of encouraging bank lending. As shown in top two figures above, it seemed to work. Bank lending growth soared as companies borrowed more for capital expenditures.

BoJ Governor Haruhiko Kuroda has trumpeted the policy’s success in boosting lending. As shown in the bottom left figure, though, lending did not increase because of the mechanism underlying YCC—that is, a widening of the gap between what banks pay to borrow funds short-term and what they receive from borrowers longer-term. Banks’ net interest margins actually fell following YCC, only recently recovering to their original levels. Whatever was driving borrowing, it was clearly not YCC’s success in boosting such margins.

What happened, then? After YCC was announced, the BoJ’s pledge to hold 10-year JGB rates at 0% pushed bond investors to find yield outside Japan. As shown in the bottom right figure, this caused the yen to fall sharply, which boosted exports. The uptick in bank loans was almost certainly driven by corporates investing in response to export activity, and not greater bank willingness to lend.

Since this explanation is transparently logical, it may seem curious that Kuroda chose to ignore it and instead to highlight an explanation unsupported by the data. His reason was almost certainly political. Back in April 2013, shortly after Prime Minister Shinzo Abe took office, the Obama administration admonished Japanese authorities for public statements calling for yen depreciation. Abe and Kuroda learned the important lesson that one may only target the exchange rate if one does not speak of it. Since then, both men have been careful not to attract Washington’s ire by stating the obvious: that in an environment of depressed demand and zero inflation, depreciation works.