Effects, Limits and Consequences of Monetary Policy Actions in the US and Japan

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1 Effects, Limits and Consequences of Monetary Policy Actions in the US and Japan Takatoshi Ito Professor, School of International and Public Affairs Columbia University For PIFS in Karuizawa October 30, 2016

2 Takeaways On the BOJ September decision: Yield Curve Control has two meaning: a cap and a floor Overshooting Commitment may likely imply the price level targeting Raising the inflation rate remains difficult Influencing inflation expectation and encouraging consumption (of younger people) may be the key but this is the third arrow 2016/10/29 (c) Takatoshi Ito 2

3 BOJ Nathan Sheets & Tsutomu Watanabe characterized BOJ as a front-runner in combatting low growth, low inflation Introduced many unconventional policies ZIRP, QE, forward guidance (time duration effect), NIRP (Sept 2016) YCC, Overshooting NIRP (Jan 2016) has been vastly unpopular Yield Curve Control has two purposes Overshooting commitment is equivalent to the price level targeting 2016/10/29 (c) Takatoshi Ito 3

4 Japan, deflation was overcome, but a slight setback recently New CORE Abenomics Headline 2016/10/29 (c) Takatoshi Ito 4

5 Prospect of inflation from here The Phillips Curve. If Alan Feldman is right, wage increase will happen and that will generate inflation Counter-argument. Wages are rising only for nonregular workers Many remain skeptical of this scenario 2% in 2 years (by end-2018)? Only 5 out of 18 people agreed 2016/10/29 (c) Takatoshi Ito 5

6 Yield Curve Control 10 yr bond rate is pegged at 0% Cap. Commitment to de facto deficit financing? Floor. If and when deepening NIRP, the yield curve becomes steeper Banks still do not like NIRP Deposit rate cannot go negative. Is it? 2016/10/29 (c) Takatoshi Ito 6

7 Overshooting my interpretation How much? And How long? Economists like overshooting as a step toward the price level targeting which is supposed to have a strong effect on the inflation expectation Policy will become path-dependent 2016/10/29 (c) Takatoshi Ito 7

8 Undershooting in the 2% trend line should be made up later 2016/10/29 (c) Takatoshi Ito 8

9 Undershooting in means more overshooting in overshooting 2016/10/29 (c) Takatoshi Ito 9

10 Price Level Targeting; History and Future History. The Riksbank in the adopted the price level targeting and overcame deflation Future. In the near future, FRB, ECB or BOE may adopt this, if BOJ succeeds in influencing on the inflation expectation 2016/10/29 (c) Takatoshi Ito 10

11 BIG PICTURE What s new in monetary policy: Old taboos become newest options QE. Reached limit? Quantity Theory of Money refuted? Monetary-fiscal coordination Old Keynesian. Fiscal policy most effective (no crowding out) with ZIRP Old Keynesian. Liquidity Trap with ZIRP Sure way to cause hyper-inflation. Deficit financing and helicopter money Long-term interest rate peg (BOJ, ) Reversal of 1951 US Treasury-FRB Accord? 2016/10/29 (c) Takatoshi Ito 11

12 So what is next? Raising the inflation rate remains difficult Influencing inflation expectation and encouraging consumption (of younger people) may be the key Monetary and Fiscal Policy can influence Aggregate Demand But only raising labor productivity can raise the real wage But, this is the third arrow 2016/10/29 (c) Takatoshi Ito 12

13 Conclusion The Japanese economy is not that bad Unemployment rate, 3% GDP gap, -1% BOJ monetary policy is approaching to its Limit Disagreement on the effectiveness and desirability of fiscal policy The strong Third Arrow is the best bet 2016/10/29 (c) Takatoshi Ito 13

14 Center on Japanese Economy and Business, Columbia Business School Takatoshi Ito The Invisible Arrow of Abenomics: Structural Reform and Innovation Wednesday, November 30, 2016 from 6:00 PM to 7:30 PM (EST) 2016/10/29 (c) Takatoshi Ito 14

15 Word on Baseball Chicago Cubs in the World Series, for the first time since 1945 Hiroshima Carp in the Nippon Series, for the first time since 1991 (unfortunately, lost the series last night) I close with a Yogi Berra quote (emulating Thierry Porte) 2016/10/29 (c) Takatoshi Ito 15

16 Baseball is 90% mental and the other half is physical. 2016/10/29 (c) Takatoshi Ito 16

17 Inflation is 90% mental and the other half is monetary. 2016/10/29 (c) Takatoshi Ito 17