This morning, the Bank of Japan decided to reverse its strategy of injecting extraordinary amounts of money into its financial system. This means that the era of the Bank of Japan's so-called quantitative monetary accommodation is over, exactly five years after it began.The BOJ's policy change validates the country's return to sustainable economic growth as well as its emergence from deflation, and will likely act as an accelerant to economic growth in Japan. While the impact on world markets from the BOJ's shift is likely to be more a process than an event, the action already has had repercussions.
Japan Was in a Liquidity TrapIn announcing its policy change, the Bank of Japan said it would reduce "the outstanding balance of current accounts at the Bank of Japan toward a level in line with required reserves." The BOJ had kept its balances at 36 trillion yen since March 2001, substantially higher than the 6 trillion yen that it is required to keep by law. In dollars, this means that Japan will reduce its excess balances from about $300 billion to about $50 billion. The money was previously needed because Japan was in the midst of a classic liquidity trap, wherein low interest rates failed to spark new lending. In fact, lending had fallen on a year-over-year basis every year since 1996 until this February, when it increased 0.2% vs. a year earlier. With Japan's economy now on more solid footing, low interest rates should be enough to motivate continued growth in lending, which means Japan is out of its liquidity trap. By changing policy, the Bank of Japan validates the recent good news in Japan and it will likely act as an accelerant growth. Potential borrowers might hasten their borrowing and consumers will no longer delay their purchases, seeing the BOJ's action as validation of Japan's emergence from deflation.
- 1) Core prices must exhibit a steady, rising trend for at least several months.
- 2) Continued increases in prices must be reported (expected for February) to assure that deflationary readings won't return.
- 3) Economy and markets must be able to withstand a reversal in policy.