Good News: BOJ comes to The Party in a Big Way.
Since the 2008 financial crisis, Global monetary policy has been a smashing disaster, so it’s nice to occasionally have good news. This morning governor Kuroda, of the bank of Japan, announced a series of monetary measures aimed at curing Japan’s chronic deflation. These are measures are far more radical than anyone expected, further even than the Fed has gone. It took decades, but they are now to listening to Milton Friedman’s recommendation from 1998. He stated that monetary expansion and the purchasing of government bonds in sufficient quantities could always cure deflation and therefore a hit any given inflation target.
The most important measure announced by the doubling of the monetary base, this is pure monetarism and demands that the economy should find a new equilibrium where the demand to hold base money has doubled. In the long run the quantity theory of money will dominate and the price level will consequently double. However in the short run as economic agents attempt to offload their excess cash spending will rise, short term interest rates will fall and spending will rise. Only over several years will inflation expectations become embedded in the price level. Since the Japanese economy remains below potential, the increases spending will lead to increased output. This increased output will ameliorate the inflation predicted by a straight application of the quantity theory of money. It is hard to predict in advance quite how much output will increase in the Japanese situation, but having had stagnant output for several decades, there must be the possibility of significant catch-up growth, despite the unfavorable demographics.
Both the Yen and the Nikki have responded strongly to this announcement of `a new era of Japanese Monetary Policy’, with open ended QE and monetary expansion the order of the day. Those who claim that monetary policy is impotent at the Zero lower bound, are about to experience disproof by counter example. Though why a 40% move in the Nikki and a 30% move in the yen on the mere expectation of expansionary policy has not been enough to convince the doubters already I do not know.
All eyes will now be on the ECB, to see if they will change course. The manufacturing PMI out today shows that every single Eurozone country expects its manufacturing output to contract. Meanwhile the ECB continues to shrink its balance sheet, since this means, effectively, that the monetary base in the EU is shrinking, it is explicitly deflationary.