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Fed Chairwoman Janet Yellen said Wednesday that “we’re struggling with…what is the new normal in this economy.”
PHOTO: GARY CAMERON/REUTERS
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By GREG IP
Sept. 21, 2016 7:52 p.m. ET
Central banks have shown the will to hit their growth and inflation targets. But do they have the way?
That question is more pointed after the Bank of Japan on Wednesday announced two new central bank firsts. It now wants inflation not just to meet its 2% target, but to overshoot it. And it will now target not just short-term interest rates, but long-term government bond yields.
The moves affirmed Governor Haruhiko Kuroda’s reputation for monetary experimentation, but also raised the more troubling question of why his previous innovations have fallen short.
Japan’s monetary travails matter to all central banks since so many countries are coming to resemble Japan, with slow growth and too-low inflation—factors that make it difficult for an economy to tolerate interest rates much above zero.
Hours after the Bank of Japan’s announcement, the Federal Reserve left its own interest rate target unchanged, while saying the case for an increase had strengthened. Though U.S. job growth is healthy, inflation is stuck below the Fed’s 2% target and bond investors expect it to stay there.
The eurozone is in the same boat: The European Central Bank has pushed interest rates below zero in an effort to boost inflation which, even excluding food and energy, is below 1%.
The situation in Japan is similar, only worse.
Japanese growth averaged 0.2% in the 12 months ending June 30, inflation is slightly negative and, most troubling, public and market expectations of inflation have slid steadily. Bond investors now anticipate inflation of only a little above zero in coming years.
On Wednesday, the yen weakened initially (the expectation of lower rates generally depresses a country’s currency), then finished the day stronger, a sign of skepticism that the new actions will succeed.
Mr. Kuroda kicked off the Bank of Japan’s aggressive stimulus in 2013 with a commitment to push inflation to 2% in two years, making massive purchases of government and corporate bonds and equities with newly created money. In January, the bank turned to negative short-term interest rates.
The actions had early success, lifting inflation out of negative territory with the help of a depreciating yen. But progress has since stalled.
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Bank of Japan Governor Haruhiko Kuroda now wants inflation not just to meet its 2% target, but to overshoot it. PHOTO:
AGENCE FRANCEPRESSE/GETTY IMAGES
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On Wednesday, the bank blamed three factors for inflation’s failure to reach 2%: the plunge in oil prices, a consumption-tax increase in 2014, and a slowdown in emerging markets.
By depressing actual inflation this drove down inflation expectations. That presents a dilemma. As long as inflation stays low, so will people’s expectations of it, a vicious circle that in turn makes it harder to get wage- and price-setting behavior to change.
The bank hopes that committing to overshooting its inflation target will push expectations higher, but it admits that “may take time” given how low actual inflation remains.
The bank also acknowledged constraints on its ability to push rates more deeply into negative territory, noting that “an excessive decline” in rates can hurt the economy by raising doubts about the financial system’s long-term health.
Japan’s economic plight shouldn’t be exaggerated. Its unemployment rate is the lowest in more than 20 years. While economic growth has been close to zero, that is partly due to a shrinking workforce and poor productivity growth.
For the same reason, the differences between Japan and other countries aren't that great. U.S. unemployment, at 4.9%, is close to the Fed’s view of its natural level, yet economic growth has been sluggish for years. Inflation and inflation expectations remain depressed.
What’s notable about the Fed’s announcement wasn’t the expected hint that it will raise rates again soon, but that there will be fewer rate increases thereafter than previously expected.
The most sobering disclosure was that officials now peg the U.S.’s long-term growth rate at 1.8%, down from 2% in June and 2.5% in 2011. “We’re struggling with…what is the new normal in this economy and in the global economy, which explains why we keep revising down the rate path,” Fed Chairwoman Janet Yellen told reporters.
The forces behind this combination of low growth and low rates go well beyond things central banks can influence. One is demographics.
Aging populations are shrinking the workforce and customer base, which saps incentives for capital expansion. Economists at Barclays noted that Japan’s shift from elderly to younger workers, from manufacturing to less-productive services, and from permanent to temporary employment are all depressing wages.
Second, productivity growth is stagnant, for reasons that aren’t clear. A third reason is fiscal tightening—efforts by governments to cut their deficits that ballooned after the recession.
Given all this, what are central banks to do? The answer, quite possibly, is nothing, or at least nothing more than what they’re now doing.
Though their policies have been less effective than hoped, they haven’t been ineffective, and if nothing derails the global economy, wages and inflation should continue to recover. The benefits of cutting rates further into negative territory may be elusive, but that isn’t a reason to jack rates up, which could trigger disruptive capital outflows from emerging markets.
There are also signs that governments around the world are loosening their budgets. In that regard, the Bank of Japan’s decision to target a zero yield on government bonds might reassure the Japanese government that it can run bigger deficits without triggering a jump in interest rates. That echoes the Fed’s pegging of bond yields in the 1940s to help the Treasury fund World War II.
The war effort produced a massive economic boom. The Fed’s job was to hold yields down in the face of so much Treasury borrowing and pent-up inflation pressure.
Today, there isn’t any similar pressure on yields from borrowing or inflation. Indeed, the Bank of Japan’s zero-bond-yield target is higher than the negative yields bonds have recently carried. The lesson is that while central banks have tools at their disposal, there is only so much they accomplish by themselves.
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