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Archives of Business Research – Vol. 12, No. 4
Publication Date: April 25, 2024
DOI:10.14738/abr.124.16794.
Kurihara, Y. (2024). Is the Balance Sheet Expansion of the Central Bank Inadequate? The Case of Japan. Archives of Business
Research, 12(4). 57-63.
Services for Science and Education – United Kingdom
Is the Balance Sheet Expansion of the Central Bank Inadequate?
The Case of Japan
Yutaka Kurihara
Faculty of Economics, Aichi University, Aichi, Japan
ABSTRACT
The Bank of Japan has continued monetary expansion to combat deflation for over
twenty years. However, in March 2024, the Bank raised the negative policy interest
rate that had lasted eight years and two months. From now on, the Bank should cope
with huge balance sheet expansion. Although yield curve control (YCC) has been
abolished, long-term interest rates will continue to be controlled to some degree
since the Bank will continue to purchase long-term government bonds. New
purchases of exchange-traded funds (ETFs) have been completed, but the main
measures of normalization, such as removing ETFs from the huge balance sheet, will
not be implemented easily because of increasing risk of stock prices decreasing.
Consequently, there will be some possibilities to lead to a rise in long-term interest
rates, a strong yen (a decrease in exports), and also to a decline in stock prices.
Empirical analyses are conducted to examine the effects of monetary expansion and
the results are positive, however, this study emphasizes the importance of the
credibility of central banks.
Keywords: Balance sheet, Central bank, Exchange rate, Government bond, Interest rate.
INTRODUCTION
The Japanese economy has been slowly recovering, although some weakness has been
observed. Looking at wage trends, corporate earnings continue to improve and the labor
market remains tight. Under these circumstances, as indicated by the results of 2024's spring
labor-management wage negotiations, firm wage increases are likely to continue in 2024, as
they did last year.
In March 2024, the Bank of Japan (the Bank; the central bank) decided to change its monetary
policy framework. The Bank judged that a virtuous cycle between wages and prices had been
achieved and that there were positive signs that the price stability target of 2 % could be
attained in a sustained way. The Bank also judged that the past policy of quantitative and
qualitative monetary easing (QQE) with yield curve control (YCC) and negative interest rate
policy had played their roles well. The Bank has provided the price stability target at 2% and,
from the perspective of achieving it sustainably and stably, will conduct appropriate monetary
policy while guiding short-term interest rates--its main conventional policy instrument--in
response to changes in economic, price, and financial conditions. The Bank will be encouraged
to lift its negative interest rate policy and set the overnight call rate at around 0-0.1%.
Moreover, the Bank has lifted its commitment on inflation overshooting with regard to the
monetary base, having determined that the conditions for its fulfilment have been met. The
Bank decided to apply an interest rate of 0.1% to its current accounts at financial institutions.
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Archives of Business Research (ABR) Vol. 12, Issue 4, April-2024
Services for Science and Education – United Kingdom
The Bank will continue its purchases of government bonds at roughly the same amount as
before. If long-term interest rates rise sharply, then the Bank will take flexible measures, such
as increasing the amount of JGB purchases and conducting fixed-rate JGB purchase operations.
Purchases of ETFs and real estate investment trusts (J-REITs) will be cancelled; purchases of
CP and corporate bonds will be continued; however, they will be discontinued after about one
year (for details, see the Bank's website: https://www.boj.or.jp/en/mopo/index.htm).
This study examines the effect of the Bank’s monetary expansion on the economy empirically.
It examines whether it could have achieved its goals or not and also considers the
appropriateness of balance sheet expansion. The Bank’s balance sheet has expanded hugely and
unprecedentedly. Section 2 reviews the Japanese economy and the Bank’s policy from the
1980s. Section 3 lists related studies and examines their relationships with this study. Section
4 considers whether the expansion of the balance sheet of the Bank is appropriate or not.
Section 5 analyzes the relationship between the balance sheet and some variant economic
variables. Finally, this study ends with a summary.
TILL THE RECENT CHANGES OF MONETARY POLICY IN JAPAN
In Japan, a phenomenon called the bubble economy occurred in the 1980s. Starting in the mid- 1980s, stock and land prices skyrocketed. It was also around this time that real estate and
companies around the world were purchased by Japanese companies. Of course, there were
side effects, but at least prices did not soar and there was no significant damage to people's
daily lives.
However, the bubble economy collapsed in the 1990s. What remained were bad loans, and the
Japanese economy would suffer from dealing with them. Japan experienced the bankruptcy of
large-scale financial institutions. There were hopes that the Japanese economy would finally
get back on its feet with the injection of public funds to dispose of bad debts, but while other
countries achieved economic growth, Japan has suffered from deflation. Wages are not rising,
consumption is not increasing, capital investment is stagnant due to concerns about the future
considering the severe economic situation, and corporate performance is worsening due to
sluggish consumption, capital investment, and fixed capital. Moreover, wages are falling,
resulting in a deflationary spiral. It has become widespread and difficult to eradicate. Around
this time, it was pointed out that the international competitiveness of Japan is declining.
In the late 1990s, exacerbated by the consumption tax rising and the Asian currency crisis,
deflation took root, making it even more difficult to escape. Of course, neither the Bank nor the
government were idle. In particular, the Bank implemented quantitative easing (QE), a
completely different and unprecedented framework of monetary policy that includes lowering
interest rates to zero, or close to zero, and purchasing large amounts of JGB.
As this would be outside the main theme of this study, this study does not go further into
monetary and fiscal policy in recent years, nor does it examine or evaluate them. However, it
should be stated that the most significant monetary policy implementation in recent years was
conducted in 2016.
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Kurihara, Y. (2024). Is the Balance Sheet Expansion of the Central Bank Inadequate? The Case of Japan. Archives of Business Research, 12(4). 57-63.
URL: http://doi.org/10.14738/abr.124.16794
In September 2016, the Bank introduced a new framework for enhanced monetary easing: QQE
with YCC. This renovated policy was constituted by two main parts: the first was ‘YCC’, where
the Bank controlled short-term and long-term interest rates; the second was ‘YCC’, where the
observed year-on-year rising of consumer price index (CPI) was over the price stability target
of 2% and remained over the target. This second part was the 'overshoot commitment', which
committed to the increasing of the monetary base till the observed year-on-year rising of the
CPI was over the price stability target of 2% and remained over the target. With regard to short- term policy rates, the Bank applied a 'negative interest rate' of minus 0.1% to current accounts
of financial institutions at the Bank. For long-term interest rates, purchases of JGB by the Bank
were intended to ensure that the yield on 10-year JGB remained at roughly the current level
(around zero percent). The Bank purchased ETFs and real estate investment trusts (J-REITs) to
the level at which their balances would increase at an annual pace respectively.
From 2020 onwards, the COVID-19 pandemic has significantly undermined not only the
Japanese economy but also the global economy. Global supply chains have been dealt a
devastating blow. In 2021, Russia invaded Ukraine, causing a rise in resource and energy prices.
On the other hand, countries in the so-called Global South, such as Brazil, India, South Africa,
and others, were supposed to enjoy more growth than before. The most notable example was
the United States (Japan, which was unable to achieve growth, could be considered an anomaly),
which quickly reduced the degree of accommodative policy and gradually raised interest rates
as evidence of this. European countries and the euro area have also decided to raise their policy
interest rates in stages, in part to curb inflation. The difference in interest rates between Japan
and the US has widened (lower in Japan and higher in the US), leading to the weakest yen level
in over 30 years. While export-led giant global companies have made large profits, small and
medium-sized enterprises and individuals have been forced to get less. It has been difficult to
raise prices. However, while prices are rising, a movement toward wage increases has become
apparent in 2024, especially among large companies.
PREVIOUS RELATED STUDIES
There are a lot of studies which examine QE in developed countries, however, there are not so
many studies which analyze the balance sheet expansion. Jeanne & Svensson (2007) show that
the analysis of central bank balance sheets is an area of the monetary policy literature where
little research has been done. And they showed that the central bank’s autonomy and
independence were, at the same time, important. Curdia and Woodford (2010) divided between
'QE' in general and asset purchases in particular, stating that the latter might be significant
when financial markets were in turmoil. Balance sheet analysis may also be useful in comparing
the balance sheets of the European Central Bank (ECB) and the Federal Reserve (FRB). Dedola
et al. (2021) found that QE shocks reduced the euro-dollar short-term money market interest
rate differential through interest rate arbitrage. They found that it depreciated the euro against
the US dollar. Karadi & Nakov (2021) showed that asset purchase policies could cause problems
because they flattened the yield curve and reduced the profitability of the banking sector, thus
delaying recapitalization. Jan-Willem & Pattipeilohy (2015) showed that changes in balance
sheet size had a positive impact on inflation expectations in Japan, while in the euro area the
impact was not so large. Reis (2017) showed that proper management of the central bank's
balance sheet could stabilize inflation and economic activity through each channel. Reynard
(2023), using an equilibrium approach, found that the central bank balance sheet expansion