Potential for the U.S. to consider zero interest rate
Bank of Japan is even considering quantitative easing ? Mutoh its Former Deputy Governor

November 06, 2008 Tetsuya Nakano

Daiwa Institute of Research chairman Toshiro Mutoh (also former Bank of Japan deputy governor) granted an exclusive interview to JBpress in the evening of November 5, immediately after the U.S. presidential election ended.

In the interview, Mutoh pointed out that the major task for the new Obama administration will be “to present a policy package that aims at early recovery of the real economic situation. This will be their first and biggest task.” Based on that acknowledgement, he forecasted the Federal Reserve Board (FRB) chairman Bernanke’s financial policy.

“It is quite possible that he is considering (to implement a zero interest rate policy) if it becomes necessary.” In addition, he made a comment on the Bank of Japan’s policy management which lowered the interest rate by 0.2% at the end of last month.

“The interest-rate policy may have to deviate from the traditional path (if the economy further deteriorates.),” expressing his acknowledgement for the potential comeback of quantitative easing policy.

JBpress: What is the major task facing the coming Obama administration?

Mutoh: Their first and the biggest task will be to present a package of policies that seeks to resolve the market chaos caused by the subprime loan crisis and bring early recovery of the real economy. Even before the presidential inauguration in January next year, Obama can already communicate many (information) points. He should know the direction of his policy once he picks his economic team members such as Treasury Secretary, chairman of Council of Economic Advisors, and economy advisor.

--How do you view the measures adopted by the Bush administration to address the financial crisis?

Mutoh: They were pressured by the market, and had no choice but to inject public funds. In Japan, the hardest part was to convince the citizens, but ironically in the U.S., the chaos in the market spared them that trouble. The plan was proposed, but what’s critical here is whether the capital injection will really take place and reduce the non-performing assets. The market continues to be sluggish because it is still uncertain as to whether “the plan will really work out or not.”

For example, specific guidelines have still not been set for purchasing bad loans. In what scale, and where do they buy what and how? Nothing is clear. The most critical point here is the purchase price. If it is too high, the government will lose money, but if it’s too low, the loss will have to be borne by the banks. They probably “have no idea what will happen as they have never attempted such a colossal undertaking before.” Some also question as to whether \70 trillion in total would really be enough. Uncertainties still remain in many points.

--What will happen to the finance and financial service policies when the Obama administration takes office?

Mutoh: Of crucial importance is how to put the brakes on falling property prices. The key to success is how the economic measures created by the new administration will affect internal demand, especially the housing market and personal consumption. Compared to Japan, the U.S. still has some room for fiscal stimulus.

They have reduced the interest rate down to 1%, but Bernanke, the FRB chairman, has not announced that it would be “the last time.” It depends on the situation, but further reduction of the interest rate is still possible. However, they are not willing to bring it down to zero at this point because the chairman knows well by learning lessons from Japan of the suffering it causes to the central banks when the interest rate drops to zero percent.

However, as a “professional for counter-recession policy,” it is quite possible that he is considering it (the implementation of zero interest rate policy) in case it becomes necessary.

■ Trend of the Financial Crisis
September 15th
Lehman Brothers went into bankruptcy.
Bank of America purchased Merrill Lynch.
The insurance giant AIG was brought under government control
The central banks of Japan, the U.S. and EU agreed coordination for fund provision in dollars.
Mitsubishi UFJ contributed capital to Morgan Stanley
Nomura Securities purchased the Asia and EU divisions of Lehman Brothers.
Inauguration of the new Aso Cabinet in Japan.
The largest U.S. S&L, Washington Mutual, filed for bankruptcy under Chapter 11.
The House voted down the financial stabilization draft.
October 3rd
The U.S. financial stability bill was passed.
The central banks of the U.S. and EU agreed to reduce their interest rates by 0.5%.
Yamato Life Insurance went bankrupt.
G7 meeting in Washington D.C. Action Plan to overcome the crisis.
Public funds were injected into nine major financial institutions in the U.S.
The currency exchange market reached $1 = \90 for the first time in 13 years.
Nikkei Average experienced its record low after the Bubble Economy (\7,162)
Additional 0.5% interest rate reduction by the U.S. FRB.
Bank of Japan reduced interest rate by 0.2%.
November 4th
The U.S. presidential election won by Mr. Obama (Democratic Party)
(The list was created by JBpress based on data sourced from media reports.)

--When will the U.S. recover from recession?

Mutoh: This leads to the question of when we will see a halt to falling property prices. Compared to the peak time in 2006, I would forecast that the prices will hit the bottom around 2010 with close to a 40% reduction rate and remain at the same level until the end of 2011. It will be 2012 before they finally start to recover.

Meanwhile, it will take at least two or three years until the chaotic financial markets finally start settling down. For this reason, the U.S. real GDP (Gross Domestic Product) growth rate is expected be around zero for 2008 and 2009. It may show some recovery in 2010, but it will be nothing significant which still falls below the potential growth rate. Similarly to the U.S., the Japanese economy is also expected to experience zero growth in 2008 and 2009, and potentially achieve a little over 1% growth in 2010.

--Bank of Japan reduced the interest rate by 0.2% on 31st of last month.

Mutoh: An interest rate reduction at this timing should normally be highly regarded. However, in the current environment which leans closely toward monetary easing, it’s not that great of an achievement considering the kind of mechanism and how much effect the additional interest rate reduction will generate.

However, the market is convinced about the interest rate reduction. When the Western nations are facing this difficult situation, it is an underestimation to consider that “Japan is not being affected as much.” We shouldn’t be so complacent. I can understand why the central bank showed their resolution while the Japanese government was attempting many measures. There are different views for (the reduction rate of) 0.2%, but it’s just like a mere difference of personal taste.
Although it wasn’t an internationally coordinated cut, Japan had no need to make a move either if the Western nations hadn’t taken action first.

--Depending on the situation, will the Bank of Japan return to zero interest rate or quantitative easing policy?

Mutoh: As a former deputy governor of the Bank of Japan, I cannot lightly voice my opinion on this topic (laugh). But speaking without such ties from the past, my objective view is that there is still potential for an additional interest rate reduction. Perhaps, they may be thinking about further reducing it by 0.2% and firmly retaining the (plus) interest rate of 0.1%.

I wouldn’t say that 0.1% is completely unnecessary, but it’s such a tiny figure as to be almost invisible. In this case, the interest rate would be pretty much zero when viewed objectively.

If the situation further deteriorates, I don’t know whether they would go for quantitative easing policy or whether they might have some new alternative ideas. But either way, they may start thinking outside of the box of traditional interest rate policy. I don’t believe it will happen for sure, but I’m in no doubt at all that the Bank of Japan has considered such possibilities when they implemented that reduction of 0.2% this time.