This week, much attention will focus on the Open Market Committee of the U.S. Federal Reserve, the most powerful central bank in the world, whose actions have global impact. Yet the most informative, and intriguing, policy decision could take place in Tokyo. And the outcome will not only tell us more about Japan’s daunting challenges, but could also signal more clearly what lies ahead for other central banks that continue to operate within an unbalanced macro-economic policy mix.
It is now widely recognized that, for most of the period since the global financial crisis, an enormous and excessive burden has been placed on central banks. Long used to playing a complimentary, albeit critical role, in policies, and mostly behind the scenes, they have taken such a dominant and visible role that they have become “the only game in town.” In the process, these monetary institutions became increasingly committed to experimental measures, from negative interest rates in Europe and Japan, to outsize involvement in financial markets in many countries as the banks deployed their balance sheets for large-scale asset purchases.
Although the central banks remain willing and able to act, questions about the effectiveness of these policies will continue to increase the longer these institutions have to go it alone. Nowhere is this issue more pressing than in Japan.
Under the leadership of its governor, Haruhiko Kuroda, the Bank of Japan has shown considerable enthusiasm for addressing decades of sluggish growth and deflationary threats. Aggressive balance sheet operations have been accompanied by a surprise plunge of policy rates into negative territory. Yet outcomes have been far from satisfactory.
Rather than depreciate the yen to promote exports and import-substitution activities at home, the currency has appreciated as the BOJ's policies became more aggressive. Adding to the central bank’s woes, bond yields have climbed significantly in recent weeks, turning a hoped-for growth tailwind into yet another potential headwind.
No wonder the Japanese central bank's policy approach has become more controversial, including among senior officials in Japan. After all, a growing set of indicators suggest that its policies have become a lot less effective, and could even be counter-productive.
This is the complex backdrop for the BOJ’s policy-making committee meeting on Sept. 20-21, which has been billed as a comprehensive review. Initial signals suggest that, despite disappointing macro-economic outcomes so far, the bank's officials are inclined to do even more, though there still seem to be disagreements about the mix of measures. Some are calling for rates to be pushed further into negative territory and others for expanding the asset purchase program. But as policy makers venture deeper into unconventional policies, the impotence of their approach could be exposed even more, triggering complex unintended economic and financial consequences, as well as inviting the risk of greater political scrutiny, interference and loss of operational autonomy.
Admittedly, it is very hard for any central bank to stand on the sidelines when a country faces the risk of even greater economic malaise. Yet the solution for the Bank of Japan’s predicament is to make any additional policy intervention conditional on the government doing more, particularly when it comes to the third arrow of its program, structural reform. But Prime Minister Shinzo Abe, whose national popularity is among the very highest in advanced economies, faces his own set of constraints.
This lose-lose situation is not unique to the Bank of Japan. At least two other systemically important central banks -- the European Central Bank and the Bank of England -- find themselves in similar straits, albeit not yet as severe. And for them, too, this growing quandary reflects the excessive and protracted reliance that has been placed on them because politicians repeatedly failed to step up to their economic policy responsibilities.
While it isn't as far along on the road to ineffectiveness as its Japanese counterpart, the situation of the European Central Bank will become more uncomfortable if member governments continue to stall on four policy priorities: pro-growth structural reform, better fiscal management, lifting pockets of crushing indebtedness and completing the regional architecture. The Bank of England could also face the risk of a similar situation if the U.K. government falters in designing a coherent Brexit strategy that also gains the support of EU members.