BOJ Operations as “World's Standard”
First-class operation, but how about finacial policy?

November 18, 2008 Bagehott

 Immediately after inaugurating its new regime with Governor Masaaki Shirakawa, who is supported by Deputy Governor Hirohide Yamaguchi, the Bank of Japan was driven to reduce interest rates. This revealed that the BOJ’s poor financial policy has still not improved. In contrast, the BOJ’s technique of financial operation boasts the world’s highest level. It seems that the BOJ’s operational method is likely to become the “world’s standard,” considering the fact that recently the Bank of England and Swiss National Bank are following the BOJ’s original method of absorbing funds, namely “writer’s bill” issuance.

Why did the BOJ decide to introduce such means of fund absorption, while the central banks all over the world were providing ample funds? First, let’s take a look at the level of monetary administration of which the BOJ is boasting.

Although rarely known, the BOJ has been noted for its high level of operation technique among the world’s central banks. Despite the fluctuation range of funds in the interbank market due to bank notes and financial funds going up by approximately several trillion yen, the BOJ is able to “lead precisely ” the official interest rates (overnight unsecured call money) almost without error.
Overseas central banks striving to stabilize their interest rates, even with less fluctuation range of funds than in Japan, seem to regard the BOJ’s operation as the hand of God.

Besides, the BOJ squarely endured the serious financial crisis of the late 1990s and overcame that by supplying abundant funds. Furthermore, in 2001, the BOJ even demonstrated the art of accumulating bank deposits of up to around 30 trillion yen, by carrying out “quantitative relaxation”: an experimental financial policy.

From sneer to admiration

However, it’s not that the “hand-of-god control” of the BOJ was truly admired.
The cause of the wide fluctuation range of funds in the interbank market is mainly financial expansion, while the financial crisis is the result of the bubble economy. In addition, the quantitative relaxation is the price of deflation. In short, it was partly the failure in economic operations that promoted the advance of the BOJ’s operational technique, and European and American central banks, enjoying their booming economies, regarded that as “acrobatics.”

In fact, the operational system of the BOJ is rather ugly. Generally speaking, the simpler the means is, the more stylish it is. If the required financial operation could be achieved with the fewest means possible, the operation would have more efficiency and elegance by just that much. At this point, the number of the BOJ’ s means to supply and absorb funds is two times more than that of Europe and America (i.e. two to three), resulting in multiple functions and ugly style.

The most acrobatic means is “writer’s bill” issuance as mentioned above. This is the technique by which the central bank issues its own debt (bill), and absorbs funds from the financial markets. Although it can be issued at any time and has high agility, it also has a dirty image of the central bank recklessly issuing national-bond-like liabilities. “We should admit that this method has no style,” says a person involved with some embarrassment.

However, as the world-wide financial crisis became more and more serious, banks in Europe and America began to look at the BOJ in a different light. Their former sneering is changing toward becoming real admiration. As the threat of liquidity appears, central banks are obliged to supply more funds and to vary their methods of financing. For the countries desperately striving to supply funds, the BOJ’s “specialty” is a very convenient textbook.

Specifically, this is the way to expand the scope of cover that the central bank makes financial institutions provide in return for financial supply, and to extend the period for fund supply, both of which follow the method of the BOJ. As for increasing the means of fund supply, Federal Reserve Bank (FRB) officials showed an extreme achievement, resulting in having more types of means than the BOJ. In the process, the BOJ’s style “was considered significantly” (according to a party involved in the BOJ).

Wise BOJ employees never boast about their operation

To complicate matters, “fund supply” does not simply mean “increasing the amount.” When supplied abundantly, funds may be excessive depending on the day, and the market interest rates become susceptible to decline beyond expectation. However, the central bank cannot cut interest rates in each case. To stabilize the official interest rates, it is necessary to absorb the extra funds. Thus, “writer’s bill” issuance drew attention as a convenient means of absorption.

Since October, numbers of central banks have introduced the “writer’s bill” method as the means for absorption. First, the Bank of England decided to adopt the method on October 6. Then, on October 10, the Riksbank (the central bank of Sweden) followed England while the Swiss National Bank determined to issue the bills on October 15. As the “writer’s bill,” once regarded as “acrobatic,” rapidly prevailed, a party involved in the BOJ happily commented, “Our operation has become a global standard!”

First-class in operation, second-class in …
However, it is unlikely that the party would have said “We have superb financial operation skill!” proudly, which may shed some light on the poor management of their core business: financial policy. The BOJ allowed low interest rates for a long period, resulting in the bubble economy of the late 1980s. Then, the central bank encouraged the bursting of the bubble economy by raising interest rates. Recently, the BOJ failed to lift the zero-rate policy in August, 2000. After the quantitative relaxation was lifted in March 2006, they also failed to normalize the interest rate.

As they forced interest to reserve deposits, the rate reduction on October 31 was scoffed at by those involved in the interbank market, because of its halfway result -- the revised range of 0.2%. However wonderful their financial operation may be, they can never pride themselves on their poor financial policy. “First-class in operation, Second-class in policy” – wise employees of the BOJ realize that this is just the kind of reaction they would provoke if they were to boast about their operation. That’s why they never do so.