Unconventional monetary recipe
The unconventional expansionary monetary policy now known as “quantitative easing” was first employed by the Bank of Japan, not by the U.S. Federal Reserve under Ben Bernanke in 2009. It is widely believed as an emergency action against the spillover of the Wall Street meltdown.
The Japanese central bank resorted to the expansive bond-purchase program in 2001 when the economy was stumbling in the so-called lost decade. The base rate was already near zero percent, yet the economy could not shake out of its deflationary spiral. Financial institutions started to go under one by one. Running out of options to bolster liquidity and bring down borrowing rates, the central bank took the unprecedented move of purchasing long-term government bonds and assets of financial institutions to boost money supply and their affordability to lend.
The action allowed money to flow again. The banks, in return, bought government bonds, which also helped to finance fiscal funds. One of two theoretical goals of quantitative easing was met. The financial market was stabilized. Insolvency in financial institutions fell sharply from 2002. But it fell short of boosting demand and inflation. The increased liquidity was not enough to boost debt as much to spur spending and investment. The mission was half-accomplished. The Bank of Korea after empirical study in 2009 concluded that quantitative easing can be helpful in stabilizing the financial market, but it is questionable in its effect on aiding the real economy.
In 2013, the Bank of Japan reactivated the bond-purchase program, seven years after the first trial. It again was without any other option to fight the deflationary specter. The central bank this time mixed it with ambitious fiscal policy and restructuring programs as an all-out effort to jump-start the economy.
When the so-called three arrows too proved to be lacking, it carried out another drastic move of pushing interest rates into negative territory. It set excess reserves at banks at minus 0.1 percent instead of the 0.1 percent kept since October 2010, which means lenders would have to pay the central bank for parking any reserves that go beyond the cap. It was admitting that the balance-sheet expansion through large-scale bond purchases cannot alone stimulate investment and consumer spending.
The previous and ongoing quantitative easing campaign also aimed at the same goal of pushing up expected inflation to spur spending by companies and individuals. The central bank was pleading to the public to spend by pulling out all the possible stops. Even as liquidity is brimming, banks have been stacking away extra funds at central bank coffers instead of lending them out. The negative interest will force them to take the funds elsewhere - lending to companies or individuals, or using them to buy bonds or stocks, to effectively spread out the liquidity.
Negative interest is a double-edged sword. The policy makers of Japan should be fully aware of the downside. Negative interests are already being tested by several European central banks. They can, in fact, be bad for banks and lead to decreased lending. The admittance of how bad the economy could be also dampens investment confidence. Yet the Japanese decided to try the risky prescription. All drugs can be life-saving or fatal depending on how they are used.
The outcome has been mixed for Sweden and Switzerland, whose central banks have been ahead in the negative-interest experiment. Since its central bank brought down the base rate to minus 0.35 percent in January last year, its economy has gotten better. The economy that grew 1 percent per annum for the three previous years, last year moved at an estimated 2.7 percent. Consumer prices rebounded above positive territory and the unemployment rate also improved. But the Swiss economy was not so lucky. Since its interest fell to the negative zone in late 2014, the growth further fell while deflation and unemployment worsened. The negative interest rate therefore cannot be a panacea for all.
Nevertheless, it need not be entirely feared. If it was all risk, the U.S. Fed would not have considered it. Chairwoman Janet Yellen in a recent Senate hearing said, “In light of the experience of European countries and others that have gone to negative rates, we’re taking a look at them again because we would want to be prepared in the event that we needed to add accommodation. We haven’t finished that evaluation.” The evaluation first started following the 2008 financial crisis. Her predecessor Ben Bernanke studied the move, although it was not taken.
All the talk may be exotic to us for now. But there will come a day when we too have to consider unconventional monetary means. If growth and inflation slips under the curve, even with the rates at zero percent, we also may not have any other choice. Unconventional or not, the policies have been acted out. Like the U.S. Fed, our central bank also should “be prepared.” The Fed was able to immediately embark on a quantitative program because it had studied Japan’s case.
Unlike the United States, eurozone and Japan, our currency is not widely circulated. Unconventional monetary actions would scare foreign capital out of the country, and we may run into a liquidity crisis. The central bank should study all possible scenarios to draw up a set of contingency plans. The government should also continue with financial diplomacy as foreign currency reserves alone cannot defend the country from capital flight. What we can do now is to prepare.
Translation by the Korea JoongAng Daily staff.
JoongAng Ilbo, Feb. 17, Page 28
The author, a former editorial writer of the JoongAng Ilbo, is an adviser at the Korea Institute of Finance.
by Kim Yeong-ook