William White is a senior adviser to the Organization for Economic Cooperation and Development (OECD), and heads the OECD’s Economic and Development Review Committee. He is making waves with a recent, fairly scathing, critique of various nations’ central banks. According to White, Central banks’ excessively liberal monetary policies are putting the global economy at risk, and he wants things to change.
This winter has been relatively mild in Japan, but at least in financial markets, it is sub-zero. Governor Haruhiko Kuroda of the Bank of Japan (BoJ) announced on 29 January that the BoJ would apply a negative interest rate of minus 0.1 percent to deposits that financial institutions hold at the Bank, starting from 16 February.
In many ways, the world has turned upside down. It is not just central banks that have set policy rates below zero, but the entire German curve out through eight years have negative yields. Japan, which has the largest debt burden relative to GDP, has negative yields out through nine years. The Swiss curve is negative through 15 years.
The Reserve Bank of Australia left the benchmark cash rate at 2.0% on Tuesday, summarising the thinking as follows:
“At today’s meeting, the Board judged that there were reasonable prospects for continued growth in the economy, with inflation close to target. The Board therefore decided that the current setting of monetary policy remained appropriate.
The Bank of Japan surprised investors last week by introducing negative interest rates. At the World Economic Forum in Davos a couple weeks ago, BOJ Governor Kuroda appeared to deny that such a move was under consideration. The market’s focus, like ours, was on the pace by which it was expanding its balance sheet (JPY80 trillion a year). The FAQ format may be the most effective way to explain what the BOJ did, why and the implications for investors.
What did the Bank of Japan do?
The Bank of Japan surprised the market. It did not expand its asset purchase plan, which was the focus of many market participants, including ourselves. Instead, following a rash of disappointing data, the BOJ introduced negative interest rates on some excess reserves and vowed to do more if necessary.
The Federal Reserve tweaked its economic assessment, but generally kept the underlying message the same. It sees slack in the labor market continuing to be absorbed and believes the economic conditions warrant a gradual increase in rates. The market was looking for a more dovish statement, but the message is little changed from December.
According to conventional economic theory, the monetisation of government debt is a recipe for fiscal profligacy and hyperinflation. It should be the last thing to which any credible central bank turns its hand. However, this is precisely what the Bank of Japan (BOJ) has been doing for the last three years.
For at least a couple of years before the Great Financial Crisis, policymakers often cautioned that investors were mispricing risk. Through the crisis, investors became painfully aware of many risks, including counterparty risk and reputation risk. Now many observers are highlighting a new risk, what they call the credibility of central banks.
The US dollar is broadly mixed as attention turns to the FOMC statement later today. The most important development has been the unexpectedly large oil inventory build reported by the API ahead of today’s government estimate.
The 11.4 mln barrel build is the largest in nearly two decades. To put the rise in perspective, consider that the US output is around 9.2 mln barrels a day. The news keeps the price of crude volatile, and yesterday’s $1.10 increase in the March light sweet contract has been completely unwound today.
