Bank of Japan To Implement "Un-Ease": A Follow-Up

We wrote yesterday in the midst of the monetary policy meeting of the Bank of Japan; we described the voluminous amount of reserves the BoJ has pumped into the banks. As widely expected, the Bank announced that it would reduce this level of reserves, pulling it back toward its more traditional amount. Because bank deposits are not near the levels permitted by the current volume of reserves, no immediate change in short-term interest rates is likely and the Bank indicates that the overnight call money rate should remain near zero.

However, the bank provided these reserves, a liability item on its balance sheet, by substantially increasing its assets, as evident in the first graph here. The BoJ's assets grew quite significantly during two periods of the last 10 years, late 1997-98 following the Asian currency crisis, and from the spring of 2001 through 2002. In this latter period, it bought huge quantities of government securities, particularly bonds, and it began outright buying of short-term commercial bills.

So as the Bank sheds the excess reserves "over a few months", it will be interesting to see what happens to interest rates on the assets the Bank will also shed. The Bank's statement says that it will continue buying long-term government bonds, and that its "un-easing" [our terminology] will occur in short-term money markets. So the Bank is attempting to minimize the impact on interest rates all together. Whether they succeed remains to be seen and it likely depends on the accompanying vigor in the Japanese economy.

Meantime, after the Bank's announcement in mid-afternoon, markets were actually encouraged, seeing this change in policy as a "vote of confidence" in the Japanese economy. Stock prices rose, with the Nikkei-225 up a whopping 2.6% on the day. And bond yields were little changed, in fact easing ever so slightly. Notably, in addition, even as the BoJ has added significantly to its holdings of government bonds in recent years, yields on them have not moved much. Thus, the yield curve has remained upward sloping, suggesting that investors believed the Bank's policy would eventually work, as it appears to be doing.

[The BoJ accounts and aggregate open market operations are included in Haver's JAPAN database. Daily stock market indexes and interest rates are shown in INTDAILY.]